Comm PA Dept Env Res v. Tri State Clinical

Opinions of the United

1999 Decisions States Court of Appeals

for the Third Circuit

6-2-1999

Comm PA Dept Env Res v. Tri State Clinical

Precedential or Non-Precedential:

Docket 98-3332

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Filed June 2, 1999

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 98-3332

COMMONWEALTH OF PENNSYLVANIA

DEPARTMENT OF ENVIRONMENTAL RESOURCES,

Appellants,

v.

TRI-STATE CLINICAL LABORATORIES, INC.,

JOSEPH NIGRO, Trustee,

Appellees.

ON APPEAL FROM THE

UNITED STATES DISTRICT COURT

FOR THE WESTERN DISTRICT OF PENNSYLVANIA

Civil Action No. 97-cv-02115

District Judge: Hon. Donald J. Lee

Argued: January 26, 1999

Before: SLOVITER, MCKEE, and RENDELL,

Circuit Judges.

(Filed June 2, 1999)

Stuart M. Bliwas, Esq. (Argued)

Pennsylvania Department of

Environmental Resources

Office of Chief Counsel

400 Market Street, P.O. Box 8464

Harrisburg, PA 17105

Attorney for Appellant

James M. Malley, Esq.

Joseph P. Nigro, Esq.

Matthew M. Pavlovich, Esq. (Argued)

Nigro & Malley

2 Gateway Center, Suite 1270

Pittsburgh, PA 15222

Attorneys for Appellees

Rachel J. Lehr, Esq.

Office of Attorney General of N.J.

25 Market Street

Trenton, N.J. 08625

Attorney for Amicus-Appellant

OPINION OF THE COURT

McKEE, Circuit Judge.

We are asked to decide if a criminal fine is entitled to

priority as an administrative expense under Chapter 7 of

the Bankruptcy Code. The fine was imposed upon a debtor

in possession for post-petition conduct that violated

Pennsylvania's Solid Waste Management Act.

Pennsylvania's Department of Environmental Resources

("DER") filed a proof of claim in which it asserted that it

was entitled to have the fine paid as an administrative

expense under S 503(b) of the Bankruptcy Code. The

bankruptcy court disagreed, and sustained the trustee's

objection to the proof of claim. The district court affirmed.

We hold that a post-petition criminal fine is not an

administrative expense under Chapter 7, and therefore we

affirm.

I. Factual Background and Procedural History

On August 14, 1990, Tri-State Clinical Laboratories, Inc.

filed a voluntary petition under Chapter 11 of the United

States Bankruptcy Code. A few months later, on October 4,

1990, two municipal workers were sprayed with blood while

emptying a dumpster located behind Tri-State's place of

business. The blood came from test tubes that Tri-State

2

had illegally placed in the dumpster. The test tubes would

have been collected and deposited in a municipal landfill

had they not been discovered.

On January 21, 1992, the Office of Attorney General filed

a criminal complaint charging Tri-State with violations of

Pennsylvania's Solid Waste Management Act for illegally

disposing of infectious waste. Count I of the complaint

charged Tri-State with unlawfully storing municipal waste

on or about July 18, 1990 (before Tri-State hadfiled its

Chapter 11 petition). Count II charged Tri-State with

unlawfully disposing of infectious waste in the dumpster on

or about October 4, 1990 (after Tri-State had filed its

Chapter 11 petition).

On September 10, 1992, Joseph P. Nigro was appointed

Chapter 11 Trustee. Shortly thereafter, on October 6, 1992,

the case was converted to Chapter 7, and Mr. Nigro was

appointed the Chapter 7 Trustee.

On July 28, 1994, while the Chapter 7 proceedings were

still pending, the Court of Common Pleas of Westmoreland

County convicted Tri-State on Counts I and II of the

complaint and imposed a fine of $10,000 for the violation

charged in Count I, and a fine of $20,000 for the violation

charged in Count II. It is undisputed that thesefines were

punitive in nature, and unrelated to actual costs or

expenses incurred by the DER.

On August 19, 1994, the DER filed a proof of claim

asserting a $10,000 subordinated unsecured claim under

11 U.S.C. S 726(a)(4); and a $20,000 claim for

administrative expenses pursuant to 11 U.S.C. SS 503(b),

507(a)(1), and 726(a)(1).1 The trustee objected to treating

the $20,000 fine as an administrative expense. However,

there was no objection to allowing the $10,000 claim for

pre-petition conduct under 11 U.S.C. S 726(a)(4), and that

fine is not an issue in this appeal.

The bankruptcy court concluded that administrative

expenses must be claimed by filing a "request for payment,"

and not by filing a "proof of claim." Accordingly, the

_________________________________________________________________

1. The bankruptcy court had previously granted the DER's motion to file

a proof of claim beyond the bar date.

3

bankruptcy court held that "[its previous] order granting

the DER leave to file its proof of claim beyond the bar date

is, in effect, a nullity." In the alternative, the court held that

the $20,000 fine for post-petition criminal conduct is not

an administrative expense under S 503(b). Instead, the

court allowed the DER to pursue the fine as an unsecured

claim.

The district court subsequently affirmed the bankruptcy

court's determination that the $20,000 fine was not an

administrative expense. Thus, it was not necessary for the

district court to decide if it agreed with the bankruptcy

court's conclusion that an administrative expense must be

asserted in a request for payment, rather than a proof of

claim. This appeal followed.2

II. Discussion

A.

The DER contends that the $20,000 fine imposed upon

the debtor in possession for conduct that occurred after it

filed the petition must be given priority status as an

_________________________________________________________________

2. The district court's appellate jurisdiction was based on 28 U.S.C.

S 158(a). We have jurisdiction pursuant to 28 U.S.C. S 158(c) and 28

U.S.C. S 1291. We exercise plenary review over a district Court's

bankruptcy decision. Universal Minerals, Inc. v. C.A. Hughes & Co., 669

F.2d 98, 100 (3d Cir. 1981). "Because the bankruptcy court, rather than

the district Court, was the trier of fact in this case, we are in as good

a

position as the district court to review the findings of the bankruptcy

court, so we review the bankruptcy court's findings by the standards the

district court should employ, to determine whether the district court

erred in its review." In re Fegeley, 118 F.3d 979, 982 (3d Cir. 1997)

(internal quotations omitted). Accordingly, we review the bankruptcy

court's findings of fact for clear error, and exercise plenary review over

legal issues. Id.

Although the parties have briefed the procedural issue of whether an

administrative expense can be asserted in a proof of claim, that issue is

not properly before us because it is not part of the district court's

order.

Moreover, because we conclude that the fines here are not administrative

expenses, we need not decide whether the administrative expense claim

was properly asserted.

4

administrative expense under S 503(b)(1)(A) of the

Bankruptcy Code. The DER bases its argument upon the

nonexclusive nature of the list of expenses in S 503(b), and

the fact that other courts have held that tort damages,

post-petition civil penalties, and civil environmental fines

are administrative expenses. The DER insists that there is

no rational basis to distinguish those civil penalties from

these criminal fines. According to the DER, both must be

treated as an "actual necessary expense of preserving the

estate" under S 503(b). Appellant's Br. at 10. The DER

seeks to bolster this argument with policy considerations. It

insists that if criminal fines are not given priority, "Chapter

11 debtors in possession [will be encouraged] to disregard

criminal statutes and other valid laws that might impede a

debtor in possession's effort to turn a profit," because such

a debtor can violate the law "secure in the knowledge that

no economic punishment would follow." Appellant's Br. at

23-24. The DER warns that this would "create[ ] an

incentive for any marginal corporate business to attempt to

free itself from regulatory restraints by seeking the safe

haven of Chapter 11 protection." Id. at 24.

The trustee's rejoinder relies heavily upon our decision in

Commonwealth of Pennsylvania Dept. of Environmental

Resources v. Conroy, 24 F.3d 568 (3d Cir. 1994). 3 The

trustee argues that we drew a distinction in Conroy

between compensatory assessments which may enjoy

priority status as actual administrative expenses, and non-

compensatory assessments which do not reimburse

creditors for actual expenses. The trustee argues that

because Congress expressly refers to non-compensatory

criminal fines and penalties elsewhere in the Code, it would

have expressly included such fines under S 503(b) if it

intended to treat them as administrative expenses. The

trustee also adds its own policy "spin" to rebut the policy

considerations that the DER urges upon us. The trustee

argues that non-compensatory criminal fines survive

bankruptcy, and can be assessed against the corporation or

_________________________________________________________________

3. Tri-State Clinical Laboratories and the trustee are jointly listed as

"appellee" on the briefs and in the caption. Inasmuch as we are deciding

the validity of the trustee's objection in the bankruptcy court we will

refer to the appellee as the "trustee."

5

corporate officers individually. Thus, those who are

responsible for the operation of the business have no

incentive to cut costs by violating the law as the DER

suggests. Appellee's Br. at 24-25.

B.

The starting point of any statutory analysis is the

language of the statute. Pennsylvania Dept. of Public

Welfare v. Davenport, 495 U.S. 552, 557-58 (1990); Kelly v.

Robinson, 479 U.S. 40, 43 (1986). Thus, we begin at the

beginning by examining the text of the statute. In doing so,

"we must not be guided by a single sentence or member of

a sentence, but look to the provisions of the whole law, and

to its object and policy." Kelly, 479 U.S. at 43 (internal

quotation marks omitted).

Section 503(b)(1)(A) of the Bankruptcy Code provides:

(b) [T]here shall be allowed, administrative expenses,

. . . including --

(1)(A) the actual, necessary costs and expenses of

preserving the estate, including wages, salaries, or

commissions for services rendered after the

commencement of the case . . .

11 U.S.C. S 503(b)(1)(A) (1997). Thus, for a claim to be given

priority as an administrative expense under this provision

of the Code, it must be (1) a "cost" or "expense" that is (2)

"actual" and "necessary" to (3) "preserving the estate."

We construe the words of a statute according to their

ordinary meaning, unless the context suggests otherwise.

See Moskal v. United States, 498 U.S. 103, 108 (1990);

Idahoan Fresh v. Advantage Produce, Inc., 157 F.3d 197,

202 (3d Cir. 1998). In Reading Co. v. Brown, the Supreme

Court concluded that "the words `preserving the estate'

include the larger objective, common to arrangements, of

operating the debtor's business with a view to rehabilitating

it." 391 U.S. 471, 476-77 (1968). The dictionary defines

"necessary" as "absolutely required" or"needed to bring

about a certain effect or result." Webster's II New Riverside

University Dictionary 787 (1994). However, the Supreme

Court has held that the concept of "necessary costs" under

6

the Code is somewhat broader than would be suggested by

the dictionary definition. Thus, " `usual and necessary

costs' should include costs ordinarily incident to operation

of a business, and not be limited to costs without which

rehabilitation would be impossible." Reading, 391 U.S. at

483.

To determine Congress' intent in enacting S 503(b)(1)(A),

we also must consider the other provisions of S 503. See

Neal v. Clark, 95 U.S. 704, 708-09 (1978) ("a word is known

by the company it keeps"). Section 503(b) specifically lists

several expenditures that are included within the meaning

of "administrative expenses." These include certain taxes

and fines or penalties that relate to those taxes, id. at

S 503(b)(1)(B) & (C); compensation for services rendered by

trustees and indenture trustees, id. at S 503(b)(2) &

S 503(b)(5); the actual, necessary expenses incurred by

certain creditors pressing their claims, id. at S 503(b)(3);

reasonable compensation for the professional services of

attorneys and accountants who provide particular services,

id. at S 503(b)(4); and other specified fees and mileage,

S 503(b)(6). These specified administrative expenses all

describe compensation for services that are necessarily

incident to the operation of a business, see, e.g.,

S 503(b)(2), (4) & (5), or reimbursement for actual expenses

incurred, see, e.g., S 503(b)(3) & (6).4 Moreover, paragraph

_________________________________________________________________

4. Although taxes incurred by the estate, as well as fines and penalties

relating to those taxes, are expressly included inS 503's definition of

administrative expense, taxes are treated uniquely throughout the

Bankruptcy Code, and the policies underlying the treatment of taxes do

not apply to other debts and expenses. Thus, the inclusion of taxes and

tax penalties in this section is not particularly helpful to our analysis.

Indeed, to the extent that the express reference to tax penalties in S 503

implies anything, it implies that Congress did not intend to include non-

compensatory criminal fines and penalties within the category of

"administrative expenses." Pursuant to well-established canons of

construction, the fact that Congress expressly included tax fines and

penalties in S 503 implies that had Congress intended to include other

types of fines and penalties within the class of administrative expenses,

it would have done so expressly. See Bates v. United States, 522 U.S. 23

(1997) (" `[W]here Congress includes particular language in one section of

a statute but omits it in another section of the same Act, it is generally

presumed that Congress acts intentionally and purposely in the

disparate inclusion or exclusion.' ") (quoting Russello v. United States,

464 U.S. 16, 23 91983) (other internal quotation marks omitted)).

7

(1)(A) designates "wages, salaries, or commissions for

services rendered after the commencement of the case" as

"actual, necessary costs and expenses of preserving the

estate." See S 503(1)(A) (emphasis added). Thus, the

language of S 503(b), read as a whole, suggests a quid pro

quo pursuant to which the estate accrues a debt in

exchange for some consideration necessary to the operation

or rehabilitation of the estate. Priority, therefore, is afforded

such expenses to compensate the providers of necessary

goods, services or labor.

Such a construction is supported by the purposes of the

Bankruptcy Code. Chapter 11 is intended to "rehabilitat[e]

the debtor and avoid[ ] forfeiture by creditors." Pioneer

Investment Services, 507 U.S. at 389. The drafters of the

Code recognized that to achieve that purpose, the debtor

has to continue to operate between the filing of the petition

and the adjudication of bankruptcy. This can result in

additional expenses that are necessary to the continued

operation of the business or to successfully winding it

down. Congress recognized this need to provide an

incentive to creditors who otherwise would not continue to

provide services to a failing business. Accordingly,"the

actual, necessary costs and expenses of preserving the

estate" are given priority under the Code. See H.R. Rep. No.

95-595, at 186-187 (1977) reprinted in 1978 U.S.C.C.A.N.

5963, 6147 ("Those who must wind up the affairs of a

debtor's estate must be assured of payment, or else they

will not participate in the liquidation or distribution of the

estate."); id. at 187, 1978 U.S.C.C.A.N. at 6147-6148 ("The

purpose of [giving priority to wages earned within three

months before bankruptcy,] as with the administrative

expense priority, is in part to ensure that employees will

not abandon a failing business for fear of not being paid.");

Report of the Commission on the Bankruptcy Laws of the

United States, H.R. Doc. 93-137, pt. 1, at 214 (1973)

[hereinafter "Commission Report to the House"]

(recommending priority status for administrative expenses

incurred during the reorganization period because"[s]uch

expenses must be paid first to assure the availability of the

services needed to administer a liquidation or

reorganization case."). Absent the priority established under

S 503, a debtor in possession could not keep its employees,

8

nor obtain services necessary to its operation as it attempts

to reorganize, or wind-down pending ultimate liquidation.

We believe the relevance of this consideration extends to

interpreting Congress' intent in according priority to certain

claims under Chapter 7.

The Supreme Court's holding in Reading illustrates these

principles. In Reading, I. J. Knight Realty Corporation filed

a petition for an arrangement under Chapter 11 of the

Bankruptcy Act which was then in effect.5 The district court

appointed a receiver, and authorized him to continue to

conduct the debtor's business of leasing an industrial

building. Thereafter the building was totally destroyed by a

fire which spread to the surrounding property. In a

resulting tort action, one of the adjacent property owners

recovered a judgment against the receiver in an effort to

obtain compensation for the damage the fire inflicted upon

its property as a result of the receiver's negligence. Because

the debtor in possession was in bankruptcy, an issue arose

as to the priority that the judgment should be accorded

against the bankrupt estate. The Supreme Court held that

the tort judgment was entitled to priority as an

administrative expense under S 64a(1) of the Bankruptcy

Act, 11 U.S.C. S 104(a)(1), even though the expense was not

technically a cost of preserving the estate.6

The Court's holding was motivated by the considerations

of fairness and practicality which underlie the purposes of

the bankruptcy laws. The Court believed that those who

continue to transact business with the debtor during the

Chapter 11 case, and who suffer financially as a result, are

entitled to priority over other creditors who have not

affirmatively assumed such risk. The Court reasoned that

_________________________________________________________________

5. The prior Bankruptcy Act is analogous to the current version.

6. Section 64a of the prior Bankruptcy Act defined administrative

expenses in relevant part as follows:

The debts to have priority, in advance of the payment of dividends

to creditors and to be paid in full out of bankrupt estates, and

the

order of payment, shall be (1) the costs and expenses of

administration, including the actual and necessary costs and

expenses of preserving the estate subsequent tofiling the petition

. . . .

9

fairness dictates that those injured by the operation of a

bankrupt business by a receiver acting within the scope of

his authority be compensated for the injury. The Court

concluded that it simply is not fair to deny innocent victims

compensation for injuries they would not have incurred had

the law not allowed the debtor to continue operating its

business. Because Reading is so important to our inquiry

we take the liberty of quoting the Court's opinion at length.

The Court stated:

In our view the trustee has overlooked one important,

and here decisive, statutory objective: fairness to all

persons having claims against an insolvent. Petitioner

suffered grave financial injury from what is here agreed

to have been the negligence of the receiver and a

workman. It is conceded that, in principle, petitioner

has a right to recover for that injury from their

`employer,' the business under arrangement, upon the

rule of respondeat superior. Respondents contend,

however, that petitioner is in no different position from

anyone else injured by a person with scant assets: its

right to recover exists in theory but is not enforceable

in practice.

That, however, is not an adequate description of

petitioner's position. At the moment when an

arrangement is sought, the debtor is insolvent. Its

existing creditors hope that by partial or complete

postponement of their claims, they will through

successful rehabilitation, eventually recover from the

debtor either in full or in larger proportion than they

would in immediate bankruptcy. Hence the present

petitioner did not merely suffer injury at the hands of

an insolvent business: it had an insolvent business

thrust upon it by operation of law. That business will,

in any event, be unable to pay its fire debts in full. But

the question is whether the fire claimants should be

subordinated to, should share equally with, or collect

ahead of those creditors for whose benefit the

continued operation of the business (which

unfortunately led to the fire instead of the hoped-for

rehabilitation) was allowed. . . . The `master,' liable for

the negligence of the `servant' in this case was the

10

business operating under Chapter XI arrangement for

the benefit of creditors and with the hope of

rehabilitation. That benefit and that rehabilitation are

worthy objectives. But it would be inconsistent both

with the principle of respondeat superior and with the

rule of fairness in bankruptcy to seek these objectives

at the cost of excluding tort creditors of the

arrangement from its assets, or totally subordinating

the claims of those on whom the arrangement is

imposed to the claims of those for whose benefit it is

instituted.

* * *

In considering whether those injured by the

operation of the business during an arrangement

should share equally with, or recover ahead of, those

for whose benefit the business is carried on, the latter

seems more natural and just. Existing creditors are, to

be sure, in a dilemma not of their own making, but

there is no obvious reason why they should be allowed

to attempt to escape that dilemma at the risk of

imposing it on others equally innocent.

391 U.S. at 477-83.

The Court also considered the practical consequences of

not allowing the tort claimant to recover ahead of other

creditors.

More directly in point is the possibility of insurance. An

arrangement may provide for suitable coverage, and

the Court below recognized that the cost of insurance

against tort claims arising during an arrangement is an

administrative expense payable in full under S 64a(1)

. . . It is . . . obvious that proper insurance premiums

must be given priority, else insurance could not be

obtained; and if a receiver or debtor in possession is to

be encouraged to obtain insurance in adequate

amounts, the claims against which insurance is

obtained should be potentially payable in full.

Id. at 483.

Thirdly, the Court considered the background of tort law.

11

It has long been the rule of equity receiverships that

torts of the receivership create claims against the

receivership itself; in those cases the statutory

limitation to "actual and necessary costs" is not

involved, but the explicit recognition extended to tort

claims in those cases weighs heavily in favor of

considering them within the general category of costs

and expenses.

Id. at 485. The Court concluded that, because the torts of

a receivership create claims against the receiver, it could

not distinguish between claims arising from conduct which

is integral to the operation of the business, and torts

arising from "nonessential" activity.

No principle of tort law of which we are aware offers

guidance for distinguishing, within the class of torts

committed by receivers while acting in furtherance of

the business, between those "integral" to the business

and those that are not. . . . We hold that damages

resulting from the negligence of a receiver acting within

the scope of his authority as receiver give rise to

"actual and necessary costs" of a Chapter XI

arrangement.

Id. Inasmuch as the receiver was acting within the scope of

its authority, the demands of fair compensation required

that persons who were injured by the receiver's negligence

be compensated. This, in turn, required giving their claims

priority over the claims of other creditors.7

Here, allowing the DER's claim to be treated as an

administrative expense will allow that claim to be paid to

the exclusion of, and out of the resources otherwise

_________________________________________________________________

7. We realize that the debtor in Reading was seeking an arrangement

under Chapter 11, and the Court reached its holding in that context.

Here, of course, the defendant initially filed for the contemporary

counterpart of an arrangement -- a reorganization-- under Chapter 11,

and the case was thereafter converted to a liquidation ("straight

bankruptcy" using the terms of the prior Bankruptcy Act). However, we

think this is a distinction without a difference. In Reading the Court

noted: "It is agreed that this section [64a] applicable by its terms to

straight bankruptcies, governs payment of administration expenses of

Chapter XI arrangements". 391 U.S. at 475.

12

available for, claims of other creditors. The practical result

would be that fines for committing crimes would be paid by

innocent third persons -- the creditors -- rather than Tri-

State -- the criminal. That is as unfair as it is impractical.

The payment of the criminal fine would not compensate for

any damages resulting from Tri-State's conduct. It would

merely cause Tri-State to satisfy its obligations to the state

out of the pockets of Tri-State's creditors.

The DER argues that the cost of complying with the

criminal laws is a necessary cost of doing business (no less

than taxes, wages, or fees), and therefore any criminal

penalties in the form of fines resulting from violating the

law must be treated as an administrative expense. Thus,

the DER would have us hold that a violation of a criminal

law intended to protect public safety is necessary or

ordinarily incident to operating a business, and therefore, is

incurred as an expense of "preserving the estate." However,

the DER fails to recognize that, even if the costs associated

with operating a business in accordance with the law are

necessary to preserving the estate, it does not follow that

criminal fines and the conduct they attempt to punish are

ordinarily incident to operating a business. We refuse to

adopt an analysis of administrative expenses that is based

upon the assumption that legitimate businesses engage in

a "cost-benefit" analysis to determine if they will comply

with criminal laws that protect the very public that the

owners and operators of those legitimate businesses are

part of. It is neither reasonable nor necessary for a

commercial enterprise to violate criminal laws and

endanger the public to preserve the estate or to conduct

legitimate business operations, and we refuse the DER's

invitation to hold otherwise. Rather, we believe Congress

intended only for those "actual necessary costs and

expenses" that arise in the context of, or compensate for,

legitimate business activity, or the losses resulting

therefrom, to be treated as expenses of preserving the

estate, and accorded priority as an administrative expense.

Although both parties to this appeal rely upon our

holding in Conroy, supra, to support their arguments, we

view Conroy as supporting the distinction we draw between

claims for compensatory expenses and those for criminal

13

fines. In Conroy, the DER filed a claim for reimbursement

for costs incurred in cleaning up hazardous chemicals at a

site the Chapter 11 debtors had attempted to abandon. In

holding that those costs were administrative expenses

entitled to priority we said:

[I]f the DER had not itself undertaken to clean up the

[site,] the Conroys could not have escaped their

obligation to do so by abandoning the hazardous

property in question. Furthermore, if Frank Conroy

had arranged for cleanup of the facility after he had

filed a Chapter 11 petition, the costs of this cleanup

would have constituted administrative expenses under

11 U.S. C. S 503(b)(1)(A), since they are a portion of `the

actual, necessary costs and expenses of preserving the

estate.'

Id. at 569. We also held that reimbursement for that

portion of the administrative and legal costs incurred in

arranging for cleanup which the DER had "sufficiently

substantiated" as reasonable compensation also qualified

as an administrative expense. Id. at 570-71. By cleaning up

the site, the DER provided a service to the debtor-- a

service that the debtor itself would have had to perform

during the course of normal operations -- and therefore,

the DER was entitled to compensation for that service.

The situation here is quite different. Tri-State was not

required to endanger the health and welfare of residents of

the community by illegally disposing of test tubes

containing blood, and the sanction that was imposed as

punishment for doing so has nothing to do with

compensation or proper business operations. Rather the

purpose of this criminal fine is deterrence, retribution, and

punishment.

C.

Our conclusion is also consistent with the legislative

history relating to the classification of non-compensatory

criminal fines and penalties. Before Congress replaced the

Bankruptcy Act of 1898 with the current Bankruptcy Code,

a creditor had to show that a claim was both "allowable"

(under S 57 of that Act), and "provable" (under S 63 of that

14

Act) before the creditor could participate in the distribution

of assets at all. See H.R. Doc. 93-137, pt. 1, at 21 (1973);

Kelly v. Robinson, 479 U.S. 36, 44-45 (1986). Section 57(j)

specifically excluded criminal penalties from the class of

allowable debts insofar as they did not compensate for an

actual loss. Section 57(j) of the Act provided:

Debts owing to the United States, a State, a county, a

district, or a municipality as a penalty or forfeiture

shall not be allowed, except for the amount of the

pecuniary loss sustained by the act, transaction, or

proceeding out of which the penalty or forfeiture arose.

30 Stat. 561 (emphasis added). Section 63 defined

"provable" debts to include criminal penalties. Thus, by the

early 1970s, when Congress began reexamining the

bankruptcy laws, it was well established that criminal fines

were not allowable debts subject to distribution from the

estate under Chapter 7.8

In 1973, the Commission on the Bankruptcy Laws of the

United States, which was established to propose changes to

the bankruptcy laws, recommended combining the concepts

of "allowable" and "provable" claims into a single enlarged

class of "allowable" claims. H.R. Doc. No. 93-137, pt.1, at

21. The Commission also recommended subordinating

certain claims to other unsecured claims within that large

class. Among this class of subordinated claims were claims

specified in S 4-406(a) of the proposed bill, including "any

claim, whether secured or unsecured, to the extent it is for

a fine, penalty or forfeiture or for multiple, punitive or

exemplary claims." Id. at 22 and pt. 2, at 115. The

Commission recommended changing the law to subordinate

such claims, rather than disallowing them, "to prevent the

debtor from obtaining a windfall of a disallowance intended

only to benefit its creditors." The Bankruptcy Reform Act:

Hearings on S. 235 and S. 236 Before the Subcomm. on

_________________________________________________________________

8. Tri-State's bankruptcy is an example of the frequency with which

cases begun under Chapter 11 eventually convert to Chapter 7. We do

not think that the conversion from Chapter 11 to Chapter 7 alters our

analysis. See Reading, supra (noting that the provisions for straight

bankruptcies govern priority under an arrangement under the prior

Code).

15

Improvements in Judicial Machinery of the Senate Comm. on

the Judiciary, 95th Cong. 761 (1975) [hereinafter "Hearings

S. 235"]. In that same Report, the Commission also

recommended establishing three categories of priority

claims: (1) administrative expenses, which the Commission

explained "must necessarily be given first priority in order

for estates to be liquidated and any distributions made to

any creditors"; (2) wages; and (3) taxes accruing within one

year prior to bankruptcy. H.R. Doc. 93-137, pt.1, at 21.

Based on the Commission's recommendations, the House

and the Senate drafted bills which provided for

subordinating and prioritizing certain kinds of claims. The

relevant provision, which was set forth in S 4-406 in both

bills, expressly subordinated any claim for a fine, penalty,

or multiple, punitive, or exemplary damages. See H.R.

10792, 93rd Cong. (1973); S. 236, 94th Cong. (1975). In

prepared remarks before the Senate subcommittee drafting

the proposed legislation, the Commission explained that

this subordination "is derived from sec. 57 of the present

Act which disallows fines, penalties, and forfeitures owing

the government. This provision simply subordinates. It

won't change the result in many cases but prevents any

return to a solvent debtor who has incurred a penalty and

extends the principle to exemplary and [sic] damages."

Hearings S. 235 at 15 (emphasis added).

In drafting the current Bankruptcy Code, Congress

considered the policy ramifications of subordinating

criminal penalties to unsecured debts. During

congressional hearings the Assistant Attorney General for

the Civil Division of the Department of Justice argued that

criminal judgments should not be subordinated, stating:

"Fine judgments represent a solemn judgment rendered

against a debtor for a crime against society. Thefine debtor

has not paid his debt to society until the fine is satisfied. As

a matter of public policy such judgments should at least

share priority with the Government's non-tax claims and

not be subordinated." Hearings S. 235 at 478. The

American Life Insurance Association argued to the contrary:

"[The Civil Division] overlooks the fact that in a bankruptcy

situation, the other creditors in effect end up paying the

fine if it is not subordinated. For that reason, it should not

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be paid out of the estate unless all other claims

(subordinated or unsubordinated) are first paid in full."

Bankruptcy Act Revision: Hearings on H.R. 31 and H.R. 32

Before the Subcomm. on Civil and Constitutional Rights of

the House Comm. on the Judiciary, 94th Cong. 1590-91

(1976). Similarly, the Securities and Exchange Commission

recommended deleting S 4-406 entirely and substituting in

its place S 57(j) of the original Bankruptcy Act, which

disallowed fines and penalties. Hearings S. 235 at 736. The

SEC favored disallowance over subordination because it

feared that subordinated fines and penalties would still

take priority over the interests of stockholders. Id.

The statute as enacted did not include a separate section

covering subordinated claims. Instead, Congress enacted

S 726, "Distribution of property of the estate," which

"dictates the order in which [sic] distribution of property of

the estate, which has usually been reduced to money by

the trustee under the requirements of section 704(1)." S.

Rep. No. 95-989, at 96-97 (1978). Section 726 provides in

relevant part:

(a) . . . [P]roperty of the estate shall be distributed--

(1) first, in payment of claims of the kind specified

in, and in the order specified in, section 507 of this

title [referring to administrative expenses under

S 503];

(2) second, in payment of any allowed unsecured

claim . . . proof of which is [timely filed under

sections 501(a), (b), or (c), or tardily filed under

section 501(a)];

(3) third, in payment of any allowed unsecured claim

proof of which is tardily filed under section 501(a)

. . .;

(4) fourth, in payment of any allowed claim, whether

secured or unsecured, for any fine, penalty, or

forfeiture, or for multiple, exemplary, or punitive

damages, arising before the earlier of the order for

relief or the appointment of a trustee, to the extent

such fine, penalty, forfeiture, or damages are not

compensation for actual pecuniary loss suffered by

the holder of such claim;

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(5) fifth, in payment of interest at the legal rate from

the date of the filing of the petition, on any claim

paid under paragraph (1), (2), (3), or (4) of this

subsection; and

(6) sixth, to the debtor.

11 U.S.C. S 726. The Senate explained paragraph (4) as

follows:

Fourth, distribution is to holders of fine, penalty,

forfeiture, or multiple, punitive, or exemplary damage

claims. More of these claims are disallowed entirely

under present law. They are simply subordinated here.

Paragraph (4) provides that punitive penalties,

including pre-petition tax penalties, are subordinated

to the payment of all other classes of claims, except

claims for interest accruing during the case. In effect,

these penalties are payable out of the estate's assets

only if and to the extent that a surplus of assets would

otherwise remain at the close of the case for distribution

back to the debtor.

S. Rep. No. 95-989 at 97 (emphasis added). Thus,

prepetition fines were accorded second class status in the

distribution scheme.

This provision works in tandem with S 523 of the current

version of the Code, which governs the dischargeability of

debts at the conclusion of the bankruptcy proceedings. To

understand S 523, however, it is useful to understand its

history as well. Section 17 of the old Bankruptcy Act

provided that a discharge in bankruptcy released a debtor

from all provable debts at the conclusion of the bankruptcy

case with four specified exceptions. Although criminal

penalties were not excepted from discharge underS 17,

courts historically had refused to discharge state criminal

penalties under federal bankruptcy because of

considerations of comity. See Kelly, 479 U.S. at 44-46. In

1978, Congress codified this judicial exception to

dischargeability of criminal fines and penalties in S 523.

That section, entitled "Exceptions to Discharge," provides:

(a) A discharge under section 727, 1141, 1228(a),

1228(b), or 1328(b) of this title does not discharge an

individual debtor from any debt --

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. . . (7) to the extent such debt is for a fine, penalty, or

forfeiture payable to and for the benefit of a

governmental unit, and is not compensation for actual

pecuniary loss, . . .

11 U.S.C. S 523(a)(7); see also FRBP Official Form 18

(9/97), Explanation of Bankruptcy Discharge in a Chapter

7 Case ("Some of the common types of debts which are not

discharged in a chapter 7 bankruptcy case are . . .[d]ebts

for most fines, penalties, forfeitures, or criminal restitution

obligations.").

The Supreme Court explained the evolution of this

exception to discharge in Kelly v. Robinson, 479 U.S. 40

(1986). In that case, a defendant was ordered to pay

restitution as a condition of probation after pleading guilty

to welfare fraud. After she was sentenced, she filed a

voluntary petition in bankruptcy under Chapter 7 listing

the restitution obligation as a debt. The appropriate state

agencies did not file a proof of claim in the court for the

outstanding restitution, but the bankruptcy court

nevertheless ruled that the restitution payments were not

dischargeable under S 523(a)(7) of the Code. The court held

that, even though restitution reimburses the victim of

criminal activity, its purpose is rehabilitation, and not

compensation. Thus, the criminal statute focused" `upon

the offender and not the . . . the victim, . . . restitution is

part of the criminal penalty rather than compensation for a

victim's actual loss.' " Kelly, 479 U.S. at 41. The district

court agreed, but the Court of Appeals for the Second

Circuit reversed. It held that restitution was a"debt" as

that term was defined in the Bankruptcy Code. It relied

upon legislative history to conclude that "Congress intended

to broaden the definition of "debt" from the narrower

definition of the Bankruptcy Act of 1898." Id. The Court of

Appeals further concluded that the restitution was

discharged under S 523(a)(7), which provides for automatic

discharge of certain debts. The Supreme Court reversed,

relying in part on an opinion the New York Supreme Court

had reached four years before Congress enacted the current

Bankruptcy Code. The Supreme Court stated:

A discharge in bankruptcy has no effect whatsoever

upon a condition of restitution of a criminal sentence.

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A bankruptcy proceeding is civil in nature and is

intended to relieve an honest and unfortunate debtor of

his debts and to permit him to begin his financial life

anew. A condition of restitution in a sentence of

probation is a part of the judgment of conviction. It

does not create a debt nor a debtor-creditor

relationship between the persons making and receiving

restitution. As with any other condition of a

probationary sentence, it is intended as a means to

insure the defendant will lead a law-abiding life

thereafter.

Thus, Congress enacted the Code in 1978 against the

background of an established judicial exception to

discharge for criminal sentences . . . an exception

created in the face of a statute drafted with

considerable care and specificity.

479 U.S. at 46 (internal quotation marks and citations

omitted).

Four years later the Supreme Court elaborated upon the

holding in Kelly, and emphasized the extent to which the

purpose of the Code was relevant to determining

dischargeability. In Pennsylvania Department of Public

Welfare v. Davenport, 495 U.S. 552 (1990), the Court held

that, even though restitution payments were not discharged

under Chapter 7, such payments were dischargeable

"debts" under Chapter 13. The Court explained:

[I]n locating Congress' policy choice regarding the

dischargeability of restitution orders in S 523(a)(7),

Kelly is faithful to the language and structure of the

Code: Congress defined "debt" broadly and took care to

except particular debts from discharge where policy

considerations so warranted. Accordingly, Congress

secured a broader discharge for debtors under Chapter

13 than Chapter 7 by extending to Chapter 13

proceedings some, but not all, of S 523(a)'s exceptions

to discharge. . . . Among those exceptions that

Congress chose not to extend to Chapter 13

proceedings is S 523(a)(7)'s exception for debts arising

from a "fine, penalty, or forfeiture." Thus, to construe

"debt" narrowly in this context would be to override the

20

balance Congress struck in crafting the appropriate

discharge exceptions for Chapter 7 and Chapter 13

debtors.

495 U.S. at 562-3.

We conclude that the policy considerations evidenced by

the aforementioned legislative history, as well as the text of

the Code and the cases interpreting it, support our view

that non-compensatory criminal fines imposed on a

Chapter 7 debtor or trustee should not be deemed

administrative expenses. This interpretation also is

consistent with Congress' limitation on the dischargeability

of criminal fines and penalties. Under Chapter 7, that

portion of a fine that is compensatory is discharged. 11

U.S.C. S 523(7). See Davenport, 495 U.S. at 559 ("The Court

in Kelly analyzed the purposes of restitution in construing

the qualifying clauses of S 523(a)(7), which explicitly tie the

application of that provision to the purpose of the

compensation required."). We do not believe that Congress

intended for us to ignore the non-compensatory character

of a criminal fine in deciding if it is an administrative

expense under S 503, while explicitly requiring that

consideration under S 523(7). Rather, for the reasons

previously stated, we conclude that S 503's restriction to

"expenses of preserving the estate" limits such expenses to

those that constitute compensation for expenditures

necessary to the operation of the debtor-in-possession's

business. As we noted above, we will not stretch our policy

analysis to include within this category the payment of the

criminal fines for Tri-State's conduct here.

We recognize, of course, that Tri-State may not have the

funds to pay this fine after the estate is liquidated.

However, that is often a possibility when criminalfines are

imposed, and we see nothing in the statutes that Tri-State

has violated, nor anything endemic to the process of

bankruptcy, that would justify us in removing the

Commonwealth's hand from the empty pockets of the

criminal, and placing it in the pockets of creditors merely

because those pockets are deeper. Tri-State was sentenced

while in bankruptcy for an act that occurred after it filed its

bankruptcy petition. The sentencing judge clearly knew

that Tri-State's ability to pay any fine was suspect at best.

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Yet, the sanction here was on the corporate entity, not

upon the responsible individuals. It should not now come

as any great surprise that the bankrupt debtor lacks the

resources to pay this criminal fine and meet its obligations

to creditors. Tri-State's precarious financial condition does

not, however, allow us to stretch the concept of

administrative expense to remedy the DER's predicament.

D.

Finally, we realize, of course, that there is a certain

tension between our analysis here, and the analysis in N.P.

Mining Co. v. Alabama Surface Mining Commission, 963

F2d. 1449 (11th Cir. 1992). There, the court held that civil

fines imposed solely as punishment for violation of

environmental regulations were entitled to priority as an

administrative expense under Chapter 11. The holding was

based upon the requirement in S 969(b) that the trustee or

debtor in possession manage and operate the property in

compliance with state law. The court of appeals reasoned

that

[i]f postpetition costs "ordinarily incident to operation

of a business" that do not confer a benefit on the estate

[the tort claims in Reading] can indeed qualify as

"actual, necessary" expenses of preserving the estate,

then a strong case can be made that when a licensed

business operates in the regulated atmosphere of strip

mining in Alabama, incurring regulatory penalties is a

cost ordinarily incident to operation of a business and

should be accorded administrative-expense priority.

Id at 1454-5.

However, we do not think that rationale applies here,

even if it is appropriate for a civil fine on a business in a

heavily regulated industry. As noted above, doing so would

require us to infer that disposing of infectious human waste

in a manner that not only endangers members of the

general public, but also constitutes criminal activity, is part

of the ordinary and necessary operations of a business.

Moreover, the court in N.P. Mining stressed that the

violation before it did not involve safety. See N.P. Mining,

963 F.2d at 1458 ("Here, there is no threat to public health

22

or safety."). We are not convinced the court's holding would

be the same if it were faced with the kind of reckless

conduct in which Tri-State engaged. Finally, the court in

N.P. Mining did not consider the extensive legislative history

regarding prepetition penalties to be as relevant as we do in

determining whether punitive criminal fines should be given

preferential treatment. See id. at 1452 (stating "[t]he

legislative history of section 503(b) as well as the legislative

history of other relevant sections of the Bankruptcy Code,

is silent regarding the treatment of punitive post petition

penalties"). Accordingly, we are not persuaded by N.P.

Mining, the cases upon which it relies, or the cases that

have relied upon N.P. Mining. See, e.g. , In re Bill's Coal

Company, Inc., 124 B.R. 827 (D. Kan. 1991); In re

Charlesbank Laundry, Inc., 755 F.2d 200 (1st Cir. 1985); In

re Double B Distributors, Inc., 176 B.R. 271 (Bky. M.D.Fla.

1994); In re Motel Investments, Inc., 172 B.R. 105 (Bky.

M.D.Fla. 1994).

III. Conclusion

In sum, based on the plain language of the Bankruptcy

Code, its purpose and legislative history, and the principles

of fairness upon which the Code is grounded, we hold that

punitive criminal fines arising from post-petition behavior

are not administrative expenses under 11 U.S.C.S 503(b),

and therefore, are not accorded priority status pursuant to

S 507(a)(1). Therefore, the orders of the Bankruptcy Court

and the District Court will be affirmed in accordance with

this decision.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

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