Petition for Writ of Certiorari — Pennsylvania Department of Environmental Protection v. Nigro, 120 S. Ct. 790 (2000) (No. 99-663)
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Court, U.S.
FILED
No. 99 663101 1819
IN THE OFFICE OF THE CLERK
Supreme Court of the Wnited States
COMMONWEALTH OF PENNSYLVANIA,
DEPARTMENT OF ENVIRONMENTAL PROTECTION,
Petitioner,
V.
JOSEPH P. NIGRO, TRUSTEE FOR THE ESTATE OF
TRI-STATE CLINICAL LABORATORIES, INC.,
Respondent.
Pctition for Writ of Certiorari to the
United States Court of Appeals
for the Third Circuit
PETITION FOR WRIT OF CERTIORARI
PAUL A. TUFANO
General Counsel
GREGORY E. DUNLAP
Deputy General Counsel
(Counsel of Record)
ROGER E. GRIMALDI
Deputy General Counsel
ANTHONY S. POTTER
Assistant General Counsel
STUART M. BLIWAS
Assistant Counsel
Commonwealth of Pennsylvania
Office of General Counsel
333 Market Street 17th Floor
Harrisburg, PA 17101-2210
Telephone: (717) 783-6563
Counsel for Petitioner
Dated: October 18, 1999
| eRe RR a ERT RN RPC AH PLO AR ARNT EE OER ATTIRE,
PACKARD PRESS® / APPELLATE DIVISION, 1617 JFK BOULEVARD, PHILA., PA. 19103 (215) 563-9000
Lp ee
~~ - . P: SS ET Oe ay ae ve
QUESTION PRESENTED
Where a debtor commits a crime during the pendency of
a Chapter 11 bankruptcy, is the resulting criminal penalty
assessed against the debtor properly classified and prioritized
as an administrative expense under the Bankruptcy Code?
LIST OF PARTIES
Petitioner is the Commonwealth of Pennsylvania, Depart-
ment of Environmental Protection (DEP), which is the admin-
istrative agency of the Commonwealth of Pennsylvania
charged with the administration of Pennsylvania’s Solid Waste
Management Act. At the time of the filing of the Proof of
Claim in this matter, the DEP was known as the Department
of Environmental Resources (DER), but was renamed the
Department of Environmental Protection pursuant to Section
501 of the Pennsylvania Conservation and Natural Resources
Act, Act of June 28, 1995 (No. 18, P.L. 89), 71 PA. STAT.
ANN. § 1340.501. Since the Petitioner was the DER at the
time of the filing of the Proof of Claim, the name DER was
carried throughout the proceedings in the lower courts.
Respondent is Joseph P. Nigro, Trustee for the Estate of
Tri-State Clinical Laboratories, Inc. The lower courts carried
Tri-State Clinical Laboratories and the Trustee as joint appel-
lees in the caption. Inasmuch as this Court is deciding the
validity of the Trustee’s objection to a claim, he is the real
party in interest.
ii
TABLE OF CONTENTS
Page
oe i
a vee Sekbaakhececesccceccesecces ii
prt OF Os oye lay |.) v
RE Ne 1
STATEMENT OF JURISDICTION.................. 1
STATUTORY PROVISION INVOLVED............. 1
STATEMENT OF THE CASE ....... ccc ccc cece ees 1
REASONS FOR GRANTING THE WRIT........... 3
I. A Criminal Penalty Imposed On A Bankruptcy
Debtor In Possession Is An Administrative
Expense Under The Bankruptcy Code And This
Court Should Review The Third Circuit’s Deci-
Re 3
A. The Third Circuit Departed From This Court's
Decision In Reading Co. v. Brown When It
Decided That Criminal Penalties Assessed For
Conduct Engaged In During A Chapter 11
Proceeding Are Not An Administrative
EE EE a re ao
B. The Court Of Appeals Justified Its Departure
‘From Reading By Misconstruing The Legisla-
tive History Of The Bankruptcy Code.......
C. The Third Circuit’s Decision Renders 28
U.S.C. § 959(b) Inoperable .................
D. The Third Circuit’s Decision Is Contrary To
This Court’s Policy That Federal Bankruptcy
Courts Should Not Invalidate State Criminal
eae eda Gg hk es ube wcsee'ee eas
E. The Third Circuit’s Decision Stands Alone
And Conflicts With The Authoritative Deci-
sions Of All Other United States Courts Of
Appeals That Have Addressed This Issue. ....
TABLE OF CONTENTS — (Continued)
soc, awsnsn aga EOE Oe TE ey: 16
APPENDIX
Commonwealth of Pennsylvania, Dep’t of Envitl.
Resources v. Tri-State Clinical Laboratories, Inc., No.
98-3332 (3d Cir. June 2, ON arictid aE a Sg la
Commonwealth of Pennsylvania, Dep’t of Envtl.
Resources v. Tri-State Clinical Laboratories, Inc., No.
97-2115 (W.D. Pa. WN tt MOP kk ba ae dba Seckckess 26a
In re Tri-State Clinical Laboratories, Inc., No. 90-22476
(Bankr. W.D. Pa. August 21, of Ry ae 30a
Commonwealth of Pennsylvania, Dep’t of Envtl.
Resources v. Tri-State Clinical Laboratories, Inc., No.
98-3332 (3d Cir. July 21, con, EE TOUT TO PEE Tee: 43a
Text of Statutory Provisions Involved................. 44a
aE Rin WO ache adic vi cy tiwescds ivcntua cnc 44a
11 U.S.C. § 93(j) (repealed) ...........000.000........ 45a
11 U.S.C. § 104(a)(1) (repealed) ...................... 45a
iv
ith A A aa a YW chen moe LN
TABLE OF AUTHORITIES
Cases Page
Alabama Surface Mining Comm’n v. N. P. Mining Co.,
Inc., (In re N. PR. Mining Co., Inc.), 963 F.2d 1449
LB Re eee rreien an 7, 11, 12
American Surety Co. v. Marotta, 287 U.S. 513 (1933).... 12
Bank of Marin v. England, 385 U.S. 99 (1966).......... 11
Bates v. United States, 522 U.S. 23 (1997) .............. 8
Cumberland Farms, Inc. v. Florida Dep’t of Envtl. Protec-
tion, 116 F.3d 16 (1st Cir. 1997)............... 7, 12, 13
Fields v. Manns, 516 U.S. 59 (1995) ..............0005. 8
In re Bill’s Coal Co., Inc., 124 B.R. 827 (D.Kan. 1991)... 7
In re Charles Bank Laundry, Inc., 755 F.2d 200 (1st Cir.
Aas Wee Wkas Caw ea wkd evaNddeea ceeds . 13
In re Mammoth Mart, Inc., 536 F.2d 950 (1st Cir. 1976).. 13
Kelly v. Robinson, 479 U.S. 36 (1986) .............000. 11
Midlantic Nat'l Bank v. New Jersey, 474 U.S. 494
IR CERCLA CAGE NS ba hawiGe do MAG AiKa4 60 kb 13
Oregon v. Witcosky, (In re Allen Care Centers, Inc.), 96
ee ee Pe err ee eee 14
Pennsylvania Dep’t of Pub. Welfare v. Davenport, 495
ec ee awae cid ccuks eo ecvekcees 14
Reading Co. v. Brown, 391 U.S. 471 (1968).......... passim
Springer v. Government of Philippine Islands, 277 U.S.
SSS GE a Dr an ee a ee 8
United States v. Barnes, 222 U.S. 513 (1912) ............ 8
TABLE OF AUTHORITIES — (Continued)
Cases, continued Page
United States Dep’t of Interior v. Elliott, 761 F.2d 168 (4th
Ce BOE. oc ccc sc caccccesavctecncssensenseses 7, 14
United States v. Noland (In re First Truck Lines, Inc.),
48 F3d 210 (6th Cir. 1995), rev’d. 517 U.S. 535
(199G). occ vecscccvcccccvccscccccccesccscecvess 8
Federal Statutes
ei lok Sere ee eee reer ree 12
Se: at 2 ner ee rr passim
11 U.S.C. § T2Ga4). oc verccccccccsvccccssccccnces 7
2B USC. §OBDD) . 0. ccc cccvecccecececevccsccccnces 9, 10
, 0) et ly. en rer err tr ence 1
State Statutes
35 PA. STAT. ANN. § 6018.701..........- eee eeeeeeees 3
Pennsylvania Conservation and Natural Resources Act,
Act of June 28, 1995 (No. 18, P.L. 89), 71 PA. STAT.
ANN. © 1340501... cc cccncrsccccccccccevececes il
Legislative Material
House Report No. 95-595, 95th Congress Second Session
(1978), Reprinted in 1978 U.S.C.C.A.N. at 6311.... 14
vi
at tw rma N
ee ert Ser
Petitioners respectfully pray that a writ of certiorari issue
to review the judgment and opinion of the United States
Court of Appeals for the Third Circuit which held that a
criminal fine imposed on a corporation for engaging in egre-
gious criminal conduct during the pendency of a Chapter 11
petition was not an administrative expense of the Chapter 11
bankruptcy estate.
OPINIONS BELOW
The Opinion of the United States Court of Appeals for
the Third Circuit is reported at 178 F.3d 685 (3d Cir. 1999). A
copy of the Opinion is reprinted in the Appendix at la. The
Opinion of the United States District Court for the Western
District of Pennsylvania is not reported, but is reprinted in the
Appendix at 26a. The Opinion of the United States Bank-
ruptcy Court for the Western District of Pennsylvania is not
reported, but is reprinted in the Appendix at 30a.
STATEMENT OF JURISDICTION
The United States Court of Appeals for the Third Circuit
issued its Opinion on June 2, 1999. On June 15, 1999, Peti-
tioner filed a Petition for Rehearing and Suggestion for
Rehearing En Banc that the United States Court of Appeals
denied on July 21, 1999 (Appendix at 43a). This Petition for
Writ of Certiorari is filed within ninety (90) days of the denial
of the Petition for Rehearing. The Court’s jurisdiction is
invokea pursuant to 28 U.S.C. § 1254.
STATUTORY PROVISION INVOLVED
The relevant statutory provision is Section 503(b) of the
United States Bankruptcy Code of 1978, 11 U.S.C. § 503(b).
This statutory provision is reprinted in the Appendix at 44a.
STATEMENT OF THE CASE
This case involves a fundamental question of whether a
criminal penalty, which is assessed by a state based upon egre-
gious criminal conduct engaged in by a debtor during the pen-
1
2
dency of a Chapter 11 bankruptcy petition, is rightly classified
and prioritized as an administrative expense under the Bank-
ruptcy Code, thereby assuring payment of the criminal pen-
alty. The underlying facts of the case are undisputed and rela-
tively uncomplicated.
Criminal Conduct
On August 14, 1990, Tri-State Clinical Laboratories, Inc.,
filed a voluntary petition under Chapter 11 of the United
States Bankruptcy Code. Shortly after Tri-State Clinical filed
its petition, on October 4, 1990, two municipal workers, Gary
Brasco and Francis Eredintario, were emptying a municipal
waste dumpster located behind Tri-State’s facility into a
municipal waste truck. After emptying the contents of the
dumpster into the truck, Mr. Brasco engaged the truck’s com-
pactor. As the compactor crushed the contents of the dump-
ster, one of Tri-State’s boxes broke open, spraying both work-
ers with blood. The blood that sprayed the workers came from
test tubes illegally dumped by Tri-State.
Criminal Proceedings
On January 21, 1992, Pennsylvania’s Office of Attorney
General filed a criminal complaint charging Tri-State with a
violation of Pennsylvania’s Solid Waste Management Act for
illegally disposing of infectious waste. On July 28, 1994, Tri-
State was convicted of violating Pennsylvania’s Solid Waste
Management Act and a $20,000 fine was assessed against Tri-
State for illegally dumping infectious waste in a municipal
dumpster.
Bankruptcy Proceedings
On September 10, 1992, respondent Joseph P. Nigro, was
appointed Chapter 11 Trustee. Shortly thereafter, on October
6, 1992, Tri-State’s bankruptcy case was converted to Chapter
7, and respondent Nigro was appointed Chapter 7 Trustee.
Sn vee atte Wana ib witha "
bated te hla as PRL Rass Wide ON Ae se We ee
3
The Department of Environmental Protection (“DEP”)
filed a proof of claim! seeking to collect the $20,000 criminal
penalty as a Chapter 11 administrative expense. The trustee,
however, objected to treating the criminal penalty, which was
assessed as a result of Tri-State’s illegal dumping of infectious
waste during the pendency of Chapter 11 proceedings, as an
administrative expense. On April 9, 1997, a hearing was held
before the bankruptcy court. At that hearing, it was concluded
that the facts were undisputed and that the only question was
whether the criminal penalty was properly classified as an
administrative expense.
On August 21, 1998, the bankruptcy court entered an
order sustaining the Trustee’s objection to the proof of claim
filed by the DEP. A timely appeal was taken by the DEP to
the United States District Court for the Western District of
Pennsylvania; however, on May 5, 1998, that court affirmed
the bankruptcy court’s decision.
An appeal was filed with the United States Court of
Appeals for the Third Circuit. On June 2, 1999, the Court of
Appeals held that the criminal penalty was not an administra-
tive expense of the Chapter 11 bankruptcy estate. Petitioner's
request for rehearing en banc was denied on July 21, 1999.
REASONS FOR GRANTING THE WRIT
I. A CRIMINAL PENALTY IMPOSED ON A BANK-
RUPTCY DEBTOR IN POSSESSION IS AN ADMINIS-
TRATIVE EXPENSE UNDER THE BANKRUPTCY
CODE AND THIS COURT SHOULD REVIEW THE
THIRD CIRCUIT’S DECISION TO THE CONTRARY.
The question presented by this petition is clear cut and
straightforward: Is a criminal fine imposed on a corporation
for engaging in egregious criminal conduct during the pen-
1. Although Pennsylvania's Office of Attorney General prosecuted this
matter, DEP is the agency charged with administering Pennsylvania's Solid
Waste Management Act and is entitled to all criminal fines collected under
the Act. See 35 PA. STAT. ANN. § 6018.701.
eee eee eee ree rere rrr eee
4
dency of a Chapter 11 petition, in order to cut costs, properly
classified as an administrative expense under Section 503 of
the Bankruptcy Code. In this case, Tri-State chose to illegally
dispose of infectious waste by dumping human blood into a
municipal dumpster during the pendency of its Chapter 11
petition solely as a cost-cutting measure. Unfortunately, the
Third Circuit’s decision, by ignoring the text of the Bank-
ruptcy Code and misconstruing legislative history to circum-
vent this Court’s decision in Reading Co. v. Brown, 391 U.S.
471 (1968), encourages other debtors in possession to engage
in similar cost-benefit analysis when deciding if they should
comply with state and federal laws. Moreover, the Third Cir-
cuit’s decision stands alone, in that it conflicts with every other
authoritative decision of a court of appeals that has considered
this issue.
A. The Third Circuit Departed From This Court's Deci-
sion In Reading Co. v. Brown, When It Decided That
Criminal Penalties Assessed For Conduct Engaged In
During A Chapter 11 Proceeding Are Not An
Administrative Expense.
In Reading, this Court held that a tort judgment resulting
from a trustee’s negligence is entitled to a priority as an
administrative expense. Specifically, the question presented in
Reading was “whether the negligence of a receiver administer-
ing an estate under a Chapter XI arrangement gives rise to an
‘actual and necessary’ cost of operating the debtor’s busines.”
Reading Co., 391 U.S. at 476. Answering this question affirma-
tively, and thereby reversing the Third Circuit, this Court rea-
soned that injuries from the operation of a debtors business
must be born by those creditors who benefit from the opera-
tion of the business under Chapter 11. /d. at 483-84. Notwith-
standing this Court's analysis in Reading, however, the Third
Circuit held that granting administrative status to a criminal
penalty would be unfair because it would reduce the amounts
otherwise available to pay innocent creditors. Appendix at
13a.
teh pa
eg nee
5
In its Opinion, the Third Circuit noted that this Court in
Reading decided that the “necessary” cost of operating a busi-
ness would include those “ordinarily incident” to its opera-
tions, and not just those without which rehabilitation would be
impossible. Appendix at 6a. Nevertheless, the circuit court
rejected the Commonwealth’s argument that the cost of com-
plying with the laws, including paying penalties for noncompli-
ance, is a cost of doing business. It stated:
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 crimi-
nal laws that protect the very public that the owners
and operators of those legitimate business are a part
of. It is neither reasonable nor necessary for a com-
mercial enterprise to violate criminal laws and
endanger the public to preserve the estate or to con-
duct 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 con-
text of ... legitimate activity ... to be ... accorded
priority as an administrative expense.
Appendix at 13a. This Court, in Reading, expressly rejected an
argument almost identical to the one the Third Circuit
accepted. In Reading, the trustee contended that the relevant
Statutory objectives are: “(1) to facilitate rehabilitation of
insolvent businesses and (2) to preserve a maximum of assets
for distribution among the general creditors should the
arrangement fail.” 391 U.S. at 476-77. Rejecting that view, this
Court stated:
In our view the trustee has overlooked one
important, and here decisive, statutory objective:
fairness to all persons having claims against an insol-
vent. 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
6
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: it’s 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 suc-
cessful rehabilitation, eventually recover from the
debtor either in full or in larger proportion then
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. ...
Reading, 391 U.S. at 477-78. The Reading decision conse-
quently requires those who will benefit from the debtor con-
tinuing in business to pay for the costs of that continuation in
business.
In the present case, the Third Circuit turned the policy
established by Reading on its head. Certainly the bankruptcy
court would have approved the cost of proper disposal of
infectious waste items; and had the debtor done so, the extra
money spent on that disposal would not have been available
to the creditors. Yet, creditors now stand to gain the money
the debtors saved precisely because the debtor deliberately
violated the law. It is particularly egregious in this case
because the illegal dumping of human blood endangered not
only the two municipal workers who were sprayed by the
blood, but public health and safety generally.
Finally, it is worth noting that since this Court’s decision
in Reading, all other circuit courts have concluded that the
post petition costs of complying with the law in a Chapter 11
7
bankruptcy is an administrative expense. See Alabama Surface
Mining Comm'n v. N. P. Mining Co., Inc., (In re N. P. Mining
Co., Inc.), 963 F.2d 1449 (11th Cir. 1992); Cumberland Farms,
Inc. v. Florida Dep’t of Envtl. Protection, 116 F.3d 16 (1st Cir.
1997); United States Dep't of Interior v. Elliott, 761 F.2d 168
(4th Cir. 1985); In re Bill’s Coal Co., Inc., 124 B.R. 827
(D.Kan. 1991). This Court should review the Third Circuit’s
contrary decision.
B. The Court Of Appeals Justified Its Departure From
Reading By Misconstruing The Legislative History Of
The Bankruptcy Code.
Seeking to justify its departure from Reading, the Third
Circuit looked to legislative history that pertained solely to
prepetition penalties. The present case by contrast involves
criminal conduct undertaken during the course of the Chapter
11 bankruptcy. Thus, legislative history relating to prepetition
penalties is simply inapposite to interpreting the statutory pro-
visions relating to postpetition penalties.
The legislative history invoked by the Third Circuit
relates only to 11 U.S.C. § 726(a)(4), which deals exclusively
with prepetition penalties. Section 726(a)(4) provides:
(a) Except as provided in ..., property of the
estate shall be distributed
(4) Fourth in payment of any allowed claim,
whether secured or unsecured, for any fine, penalty,
or forfeiture ..., arising before the earlier of the
order for relief or the appointment of a trustee, . . .
11 U.S.C. § 726(a)(4) (emphasis added). DEP is not arguing
that prepetition penalties are entitled to Chapter 11 adminis-
trative claim status. Instead, this case only involves criminal
penalties for conduct that occurred during Tri-State’s Chapter
11 reorganization.
Ignoring the distinction between prepetition and postpe-
tition penalties, the Court of Appeals isolated itself from the
8
context of the Bankruptcy Code and magnified the legislative
history relating to prepetition penalties in order to demon-
strate that Congress never intended for postpetition penalties
to be classified as an administrative expense. The Third Cir-
cuit’s misuse of legislative history in this way to bolster its
conclusion and validate its misreading of this Court’s prece-
dent is simply astounding.?
A similar method of analysis was employed by the Sixth
Circuit in United States v. Noland, (In re First Truck Lines,
Inc.), 48 F.3d 210 (6th Cir. 1995), rev’d 517 U.S. 535 (1996),
when the Sixth Circuit concluded that it should equitably sub-
ordinate postpetition tax penalties, simply because the Bank-
ruptcy Code subordinated prepetition penalties. This Court
soundly repudiated that case because Congress clearly had not
seen fit to subordinate postpetition tax penalties and the
courts have no right to reverse that conclusion. See Noland,
517 U.S. at 543. Congress clearly knew how to subordinate
prepetition penalties; when it did not impose the same restric-
tions on postpetition penalties, it intended a different treat-
ment.
2. The Court of Appeals cites Bates v. United States, 522 U.S. 23 (1997),
for support for its conclusion that criminal fines and penalties should not be
treated as “administrative expenses” under the Bankruptcy Code. Appendix
at 7a, n.4. Specifically, Bates stated “where Congress included particular lan-
guage in one section of a statute but omits in another section of the same
Act, it is generally presumed that Congress acts intentionally, and purposely
in desperate inclusion or exclusion.” 522 U.S. at 29-30.
This maxim of expressio unis “expresses a rule of construction and not
of substantive law.” United States v. Barnes, 222 U.S. 513 (1912). As such,
expressio unis, must serve “only as an aid in discovering the legislative intent
when that is not otherwise manifest.” 222 U.S. at 519. Reliance on the
maxim of expressio unis “must yield whenever a contrary intention on the
part of the law maker is apparent.” Springer v. Government of Philippine
Islands, 277 U.S. 189, 206 (1928). In fact, the rule is “weakest when it sug-
gests results strainly at odds with other textual pointers.” Field v. Manns, 516
U.S. 59, 75 (1995). In this case, the text of section 503(b) makes clear that
Congress never intended the list of administrative expenses to be compre-
hensive; instead, the list is merely illustrative.
9
C. The Third Circuit’s Decision Renders 28 U.S.C.
§ 959(b) Inoperable.
The effect of the panel decision is that it totally emascu-
lates the provision of 28 U.S.C. § 959(b), which requires that a
debtor in possession operate a business in accordance with
state laws. Section 959(b), provides as follows:
... @ trustee, receiver or manager appointed in any
cause pending in any court of the United States,
including a debtor in possession, shall manage and
operate the property in his possession as such
trustee, receiver or manager according to the
requirements of the valid laws of the State in which
such property is situated, in the same manner that
the owner or possessor thereof would be bound to
do if in possession thereof.
28 U.S.C. § 959(b) (emphasis added). Thus, Congress
expressly requires every debtor in possession to operate a
business in accordance with state law.
In order to have any deterrent effect, criminal and civil
penalties assessed during the pendency of a Chapter 11 peti-
tion must be treated as a cost and expense of doing business
like any other expense. It is axiomatic that the purpose of a
penalty is to encourage compliance with the law. Any deter-
rent effect, however, is lost if a debtor operating postpetition
is allowed to do so with impunity, knowing that any penalty is
characterized as a general unsecured claim and, therefore, in
all probability will never be paid. Treating the criminal penalty
as an administrative expense insures its payment, thereby rein-
forcing the deterrent effect by not allowing a debtor in posses-
sion and creditors to benefit from engaging in cost-cutting
criminal behavior. Any other result gives a debtor in posses-
sion not only a distinct commercial advantage over those oper-
ating businesses outside bankruptcy, but an incentive to
engage in criminal conduct to cut costs. Certainly this is not
19
what Congress intended when it specifically required a debtor
in possession to comply with valid state laws.
The cost of complying, or the cost of paying a penalty for
not complying with a law, are expenses incident to the opera-
tion of a business whether the business has filed for Chapter
1] reorganization or not. Indeed, any natural reading of Sec-
tion 959(b) mandates that a penalty, whether criminal or civil,
imposed for unlawful conduct by a debtor during the pen-
dency of a Chapter 11 petition be granted priority as an
administrative expense.
D. The Third Circuit’s Decision Is Contrary To This
Court’s Policy That Federal Bankruptcy Courts
Should Not Invalidate State Criminal Proceedings.
Contrary to the well-established policy of this Court, the
Third Circuit’s decision nullifies a criminal penalty imposed by
Pennsylvania for conduct that occurred during the pendency
of Tri-State’s Chapter 11 bankruptcy petition. The Third Cir-
cuit’s decision places great weight upon the fact that in a
Chapter 7 bankruptcy there is only a finite amount of money
available for creditors. Thus, for every dollar that is paid
toward a criminal penalty in a Chapter 7 bankruptcy, there is
one less dollar available to pay creditors. The Third Circuit's
analysis is fundamentally flawed for two reasons.
First, it is much more important to insure that a Chapter
11 debtor has an economic incentive to obey the law than it is
for federal courts to protect the resources available to pay
creditors that had a business relationship with a debtor. Sec-
ond, not every Chapter 11 bankruptcy proceeding converts to
Chapter 7 and, in those cases that do not convert, the amount
of money to pay creditors is not finite. Consequently, one must
assume that the case will not convert from Chapter 11 to
Chapter 7. Unfortunately, the Third Circuit’s decision
expresses more concern for protecting the resources available
to creditors in Chapter 7 liquidation than with insuring that
corporate debtors comply with state laws.
)
«
11
This Court has clearly set contrary policy through its deci-
sion in Kelly v. Robinson, 479 U.S. 36 (1986). In Kelly, this
Court interpreted Section 523(a)(7) as prohibiting the dis-
charge of criminal penalties assessed against individuals, rea-
soning that the basis for the exception to discharge is a deep
conviction that federal bankruptcy courts should not invali-
date state criminal proceedings. Kelly, 479 U.S. at 49. Quoting
Justice William O. Douglas, this Court wrote:
We do not read these statutory words with the ease
of a computer. There is an overriding consideration
that equitable principals govern the exercise of
bankruptcy jurisdiction.
Id. quoting Bank of Marin v. England, 385 U.S. 99 (1966). This
Court has long recognized that the states’ interest in adminis-
tering their criminal justice systems free from federal interfer-
ence is one of the most powerful of the considerations that
should influence a court considering equitable types of relief.
“This reflection of our federalism must also influence our
interpretation of the bankruptcy code.” Jd. Those words are a
strong reminder of just how strictly this Court views the need
to accord respect to a state’s criminal proceedings.
E. The Third Circuit's Decision Stands Alone And Con-
flicts With The Authoritative Decisions Of All Other
United States Courts Of Appeals That Have
Addressed This Issue.
The Third Circuit was not the first court to address this
issue, although its conclusion is unique. In fact, the Third Cir-
cuit recognized that its decision was in tension with other Cir-
cuit Court decisions but expressly chose to deviate from those
opinions. Appendix at 22a.
The most comprehensive analysis of the status of Chapter
11 and Chapter 7 administrative fines and penalties was made
by the Eleventh Circuit in Jn re N. PR. Mining Co., 963 F.2d
1449 (11th Cir. 1992). N. PR Mining involved a situation in
which the debtor in possession violated environmental laws
12
while it was operating during the Chapter 11 administration of
the bankruptcy case. Civil penalties were imposed upon the
debtor as a result of those violations. On the basis of the civil
penalties, the Alabama Surface Mining Commission filed an
administrative claim pursuant to Section 503(b) of the Bank-
ruptcy Code, which provides as follows:
After notice and a hearing, there shall be allowed
administrative expenses, . . . including
(1)(A) the actual, necessary costs and expenses
of preserving the estate, including ...; (emphasis
added)
The N. P Mining court held that “punitive civil penalties
assessed for postpetition mining activities qualify as an admin-
istrative expense under Section 503(b)(1)(A).” N. P Mining,
963 F.2d at 1459. The rational used by the Eleventh Circuit
was that there was a need to force trustees and “debtors in
Possession” to comply with state laws, pursuant to 28 U.S.C.
§ 959(b), and the Code’s Rule of Construction contained in 11
U.S.C. § 102(3) relating to the word “including” in Section
503(b).3 The N.P Mining court concluded that “penalties
assessed for mining violations that are sustained during the
operation of a mine by the debtor in possession or the Trustee
shall be given administrative expense status ...” Jd. at 1461.
The First Circuit in the case of Cumberland Farms v.
Florida Dep’t of Envtl. Protection, 116 F.3d 16 (1st Cir. 1997),
took the same approach as the Eleventh Circuit. In Cumber-
land Farms, a network of combined convenience stores and
gas stations located in Florida were operated by the debtor in
possession. Cumberland Farms operated its underground stor-
age tank sites after filing a Chapter 11 petition for a period of
17 months without complying with Florida’s reporting require-
ments and pertinent regulations. Florida’s DEP fined Cumber-
land Farms $200,000, which the bankruptcy court and district
3. 11 U.S.C. § 102(3) is based upon this Court's decision in American
Surety Company v. Marota, 287 U.S. 513 (1933).
13
court concluded had Chapter 11 administrative expense prior-
ity. The First Circuit, in affirming the district court, held:
It is now abundantly clear that in state regulated
areas such as protection of the environment, a bank-
ruptcy court must comply with the laws of the state
involved. [citation omitted] Debtors in Possession,
such as Cumberland, do not have carte blanche to
ignore state and local laws protecting the environ-
ment against pollution. Midlantic Nat’l Bank v. New
Jersey Dep’t of Envtl. Protection, 474 U.S. 494
(1986).
Cumberland Farms, 116 F.3d at 19-20. The First Circuit then
found that under Reading Co. v. Brown, “the payment of a
fine for failing during bankruptcy to meet the requirements of
a state environmental protection law” is a cost “ordinarily
incident to the operation of business in light of today’s exten-
sive environmental regulations.” Jd. at 20.
_
In coming to its conclusion in Cumberland Farms, the
First Circuit reviewed this Court’s decision in Reading and two
of its prior rulings on similar questions. First, in Jn re Charles
Bank Laundry, Inc., 755 F.2d 200 (1st Cir. 1985), the First Cir-
cuit held that a fine for violation of a temporary injunction
during the pendency of a bankruptcy was properly classified as
an administrative claim. Second, in In re Mammoth Mart, Inc.,
536 F.2d 950 (1st Cir. 1976), the First Circuit found that admin-
istrative status should be given to claims of creditors injured
by the debtor in possession’s operations of the business if their
claims did not arise from the transactions that were necessary
to preserve or rehabilitate the estate. After reviewing Reading
and its own prior precedent, the First Circuit affirmed the
$200,000 Chapter 11 administrative expense priority holding
that “it would be fundamentally unfair to allow Cumberland
Farms to flout Florida’s environmental protection laws and
escape paying a penalty for such behavior.” Cumberland
Farms, 116 F.3d at 21.
14
The Third Circuit's decision is also contrary to and con-
flicts with that of the Fourth Circuit in United States Dep’t of
Interior v. Elliott, 761 F.2d 168 (4th Cir. 1985). Elliott involved
a mining corporation operating as debtor in possession that
was cited for several violations of the federal Surface Mining
Conservation and Reclamation Act. Penalties were assessed
for this postpetition conduct in the amount of $69,750. The
lower courts in Elliott held that only tax penalties incurred by
a Trustee while operating a debtor’s business were allowable
as postpetition administrative expenses. The Fourth Circuit
rejected this holding and ruled that former Section 57 (j) of
the bankruptcy act,‘ allowed “all postpetition penalty claims
regardless of their type and regardless of whether they were
incurred by the Trustee or by the debtor in possession.”
Elliott, 761 F.2d at 171.
Moreover, the fact that N. P Mining, Cumberland Farms,
and Elliott addressed civil penalties rather than criminal fines
makes no difference as to a conflict between the circuits.
Indeed, this Court specifically found in the case of Pennsylva-
nia Dep't of Pub. Welfare v. Davenport, 495 U.S. 552, 561-2,
(1990), that there was no difference between the way criminal
and civil sanctions were treated in the Bankruptcy Code.
Finally, the Third Circuit’s decision leaves states in a
quandary. The Ninth Circuit in Oregon v. Witcosky, (In re
Allen Care Centers, Inc.), 96 F.3d 1328 (9th Cir. 1996), held
that the state could not recover costs incurred in providing
care and safe transfer of residents after the closing of a failing
nursing home, which was operated by the debtor, because the
expenses were not a result of the debtors wrongdoing, but
simply from its insolvency. Witcosky, 96 F.3d at 1331. Accord-
ingly, in the Ninth Circuit, a state only receives administrative
4. The fact that Elliou was decided under the former Bankruptcy Act
rather than under the current Bankruptcy Code is of no consequence. Cur-
rent Section 503(b)(1)(A) is virtually identical to former Section 64(a)(1) of
the Bankruptcy Act, on which the claim in that case is based. The Elliott
decision was not legislatively written out of the Bankruptcy Code and
remains valid law today. See House Report No. 95-595, 95th Congress Sec-
ond Session (1978), reprinted in 1978 U.S.C.C.A.N. at 6311.
15
expense priority if the debtor engages in wrongdoing. By con-
trast, in the Third Circuit, the very fact that there is a criminal
violation bars the expense from being administrative. Cur-
rently, either all the other courts of appeals that have consid-
ered the issue and determined that penalties assessed by a
state for illegal conduct engaged in during the pendency of a
Chapter 11 petition are entitled to administrative expense sta-
tus are wrong, or the Third Circuit is mistaken in its analysis
in this case. Either way it is essential that this Court resolve
this conflict.
16
CONCLUSION
For all the foregoing reasons, petitioner respectfully
requests that this Court grant its Petition for Writ of Cer-
tiorari to the United States Court of Appeals for the Third
Respectfully submitted,
PAUL A. TUFANO
General Counsel
GREGORY E. DUNLAP
Deputy General Counsel
(Counsel of Record)
ROGER E. GRIMALDI
Deputy General Counsel
ANTHONY S. POTTER
Assistant General Counsel
STUART M. BLIWAS
Assistant Counsel
Office of General Counsel
333 Market Street 17th Floor
Harrisburg, PA 17101-2210
Telephone: (717) 783-6563
Counsel for Petitioner
APPENDIX
\
la
No. 98-3332
United States Court of Appeals
for the Ghird Circuit
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, RENDELL, Circuit Judges.
(Filed June 2, 1999)
STUART M. BLIWAS, Esq. (Argued)
Pennsylvania Department of
Environmental Resources
Office of Chief Counsel
400 Market Street, PO. 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
| eee
2a
OPINION OF THE COURT
McKEE, Circuit Judge.
We are asked to decide if a criminal fine is entitled to pri-
ority 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 Pennsylva-
nia’s Solid Waste Management Act. Pennsylvania’s Depart-
ment 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 § 503(b) of the Bank-
ruptcy 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 busi-
ness. The blood came from test tubes that Tri-State had ille-
gally 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 Acct for illegally dis-
posing 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 had filed its Chapter 11 peti-
tion). 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).
STOOLS LR GR AOR ie SLL BAAN ices is Wek LS its
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3a
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 com-
plaint 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 these fines 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. § 726(a)(4); and a $20,000 claim for administrative
expenses pursuant to 11 U.S.C. §§ 503(b), 507(a)(1), and
726(a)(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. § 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 bank-
ruptcy 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 § 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
1. The bankruptcy court had previously granted the DER's motion to
file a proof of claim beyond the bar date.
4a
court’s conclusion that an administrative expense must be
asserted in a request for payment, rather than a proof of
claim. This appeal followed.?
Il. 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 administrative
expense under § 503(b)(1)(A) of the Bankruptcy Code. The
DER bases its argument upon the nonexclusive nature of the
list of expenses in § 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 pre-
serving the estate” under § 503(b). Appellant's Br. at 10. The
DER seeks to bolster this argument with policy consider-
ations. It insists that if criminal fines are not given priority,
“Chapter 11 debtors in possession [will be encouraged] to dis-
regard criminal statutes and other valid laws that might
impede a debtor in possession’s effort to turn a profit,”
2. The district court's appellate jurisdiction was based on 28 U.S.C.
§ 15 8(a). We have jurisdiction pursuant to 28 U.S.C. § 158(c) and 28 U.S.C.
§ 1291. We exercise plenary review over a district Court's bankruptcy deci-
sion. 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 deter-
mine whether the district court erred in its review.” In re Fegeley, 118 F.3d
979, 982 (3rd 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. /d.
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. More-
over, because we conclude that the fines here are not administrative
expenses, we need not decide whether the administrative expense claim was
properly asserted.
AMEE ae NAL dal Sa AI Ab EAS new 7
Sa
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 “cre-
ate[] an incentive for any marginal corporate business to
attempt to free itself from regulatory restraints by seeking the
safe haven of Chapter 11 protection.” /d. 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 compen-
satory 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
§ 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
corporate officers individually. Thus, those who are respon-
sible 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.
The starting point of any statutory analysis is the lan-
guage 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 exam-
ining the text of the statute. In doing so, “we must not he
guided by a single sentence or member of a sentence, but look
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.”
oa
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 pre-
serving the estate, including wages, salaries, or commis-
sions for services rendered after the commencement of
the case...
11 U.S.C. § 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, com-
mon 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 I]
New Riverside University Dictionary 787 (1994). However,
the Supreine Court has held that the concept of “necessary
costs” under the Code is somewhat broader than would be
suggested by the dictionary definition. Thus, “ ‘usual and nec-
essary costs’ should include costs ordinarily incident to opera-
tion 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 § 503(b)(1)(A),
we also must consider the other provisions of § 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 “admin-
istrative expenses.” These include certain taxes and fines or
penalties that relate to those taxes, id. at § 503(b)(1)(B) &
7a
(C); compensation for services rendered by trustees and
indenture trustees, id. at § 503(b)(2) & § 503(b)(5); the actual,
necessary expenses incurred by certain creditors pressing their
claims, id. at § 503 (b)(3); reasonable compensation for the
professional services of attorneys and accountants who pro-
vide particular services, id. at § 503(b)(4); and other specified
fees and mileage, § 503(b)(6). These specified administrative
expenses all describe compensation for services that are nec-
essarily incident to the operation of a business, see, e.g.,
§ 503(b)(2), (4) & (5), or reimbursement for actual expenses
incurred, see, e.g., § 503(b)(3) & (6).4 Moreover, paragraph
(1)(A) designates “wages, salaries, or commissions for services
rendered after the commencement of the case” as “actual, nec-
essary costs and expenses of preserving the estate.” See
§ 503(1)(A) (emphasis added). Thus, the language of § 503(b),
read as a whole, suggests a quid pro quo pursuant to which the
estate accrues a debt in exchange for some consideration nec-
essary to the operation or rehabilitation of the estate. Priority,
therefore, is afforded such expenses to compensate the provid-
ers 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 Invest-
4. Although taxes incurred by the estate, as well as fines and penalties
relating to those taxes, are expressly included in § 503's definition of admin-
istrative 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 § 503 implies anything, it
implies that Congress did not intend to include non-compensatory criminal
fines and penalties within the category of “administrative expenses.” Pursu-
ant to well-established canons of construction, the fact that Congress
expressly included tax fines and penalties in § 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)).
8a
ment 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 recog-
nized 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 “Commis-
sion 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 liquida-
tion or reorganization case.”). Absent the priority established
under § 503, a debtor in possession could not keep its employ-
ees, nor obtain services necessary to its operation as it
attempts to reorganize, or wind-down pending ultimate liqui-
dation. 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 Bank-
ruptcy Act which was then in effect.5 The district court
appointed a receiver, and authorized him to continue to con-
5. The prior Bankruptcy Act is analogous to the current version.
Sy pcan Midas: iP ele.
9a
duct 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 § 64a(l) of the
Bankruptcy Act, 11 U.S.C. § 104(a)(1), even though the
expense was not technically a cost of preserving the estate.®
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 pri-
ority over other creditors who have not affirmatively assumed
such risk. The Court reasoned that 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.
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 administra-
tion, including the actual and necessary costs and expenses of preserv-
ing the estate subsequent to filing the petition. .. .
10a
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 oper-
ating 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 impor-
tant, 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 prin-
ciple, petitioner has a right to recover for that injury
from their ‘employer,’ the business under arrange-
ment, upon the rule of respondeat superior. Respon-
dents contend, however, that petitioner is in no
different position from anyone else injured by a per-
son 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 suc-
cessful 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 busi-
ness (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 business operating under Chapter
MERE So 2 RR SR IR Sle At Rat DOE Reet ph ail aide tales LAOS
lla
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. 3
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 § 64a(I) ... 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.
12a
Thirdly, the Court considered the background of tort law.
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 limi-
tation 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 inte-
gral 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 further-
ance of the business, between those “integral” to the
business and those that are not.... We hold that
damages resulting from the neligence of a receiver
acting within the scope of his authority as receiver
give rise to “actual and necessary costs” of a Chap-
ter XI arrangement.
Id. Inasmuch as the receiver was acting within the scope of its
authority, the demands of fair compensation required that per-
sons who were injured by the receiver’s negligence be com-
pensated. This, in turn, required giving their claims priority
over the claims of other creditors.’
Here, allowing the DER'’s claim to be treated as an
administrative expense will allow that claim to be paid to the
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 with-
out 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.
tenets ve
ncaa sisal ste
l3a
exclusion of, and out of the resources otherwise 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 crimi-
nal. 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 penal-
ties 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 recog-
nize 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 pub-
lic that the owners and operators of those legitimate busi-
nesses 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 busi-
ness 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 administra-
tive expense.
Although both parties to this appeal rely upon our hold-
ing in Conroy, supra, to suport their arguments, we view Con-
Ida
roy as supporting the distinction we draw between claims for
compensatory expenses and those for criminal fines. In Con-
roy, 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. § 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. /d. at 570-71. By cleaning up the site, the DER pro-
vided 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 compen-
sation 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 busi-
ness operations. Rather the purpose of this criminal fine is
deterrence, retribution, and punishment.
Cc.
Our conclusion is also consistent with the legislative
history relating to the classification of non-compensatory
criminal fines and penalties. Before Congress replaced the
Se fi Re ee te
1Sa
Bankruptcy Act of 1898 with the current Bankruptcy Code, a
creditor had to show that a claim was both “allowable” (under
§ 57 of that Act), and “provable” (under § 63 of that 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 § 4-406(a)
of the proposed bili, 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.” Jd. at 22 and pt.
2, at 115. The Commission recommended changing the law to
subordinate such claims, rather than disallowing them, “to
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 gov-
ern priority under an arrangement under the prior Code).
16a
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 Sub-
comm. on 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 bank-
ruptcy. 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 provi-
sion, which was set forth in § 4-406 in both bills, expressly
subordinated any claim for a fine, penalty, or multiple, puni-
tive, 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, penal-
ties, and forfeitures owing the government. This provision sim-
ply subordinates. /t 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] dam-
ages.” Hearings S. 235 at 15 (emphasis added).
In drafting the current Bankruptcy Code, Congress con-
sidered the policy ramifications of subordinating criminal pen-
alties 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 sol-
emn judgment rendered against a debtor for a crime against
society. The fine debtor has not paid his debt to society until
the fine is satisfied. As a matter of public policy such judg-
ments should at least share priority with the Governnient’s
non-tax claims and not be subordinated.” Hearings S. 235 at
478. The American Life Insurance Association argued to the
17a
contrary: “(The Civil Division] overlooks the fact that in a
bankruptcy situation, the other creditors in effect end up pay-
ing the fine if it is not subordinated. For that reason, it should
not be paid out of the estate unless all other claims (subordi-
nated 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 delet-
ing § 4-406 entirely and substituting in its place § 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 stock-
holders. Jd.
The statute as enacted did not include a separate section
covering subordinated claims. Instead, Congress enacted
§ 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)... [PJroperty 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
§ 503);
(2) second, in payment of any allowed unsecured
claim ... proof of which is [timely filed under sec-
tions 501(a), (b), or (c), or tardily filed under sec-
tion 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, pen-
alty, or forfeiture, or for multiple, exemplary, or
punitive damages, arising before the earlier of the
18a
order for relief or the appointment of a trustee, to
the extent such fine, penalty, forfeiture, or dam-
ages are not compensation for actual pecuniary
loss suffered by the holder of such claim;
(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. § 726. The Senate explained paragraph (4) as
follows:
Fourth, distribution is to holders of fine, penalty, for-
feiture, 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 subordi-
nated 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 § 523 of the current
version of the Code, which governs the dischargeability of
debts at the conclusion of the bankruptcy proceedings. To
understand § 523, however, it is useful to understand its his-
tory as well. Section 17 of the old Bankruptcy Act provided
that a discharge in bankruptcy released a debtor from all prov-
able debts at the conclusion of the bankruptcy case with four
specified exceptions. Although criminal penalties were not
excepted from discharge under § 17, courts historically had
refused to discharge state criminal penalties under federal
bankruptcy because of considerations of comity. See Kelly, 479
19a
U.S. at 44-46. In 1978, Congress codified this judicial exception
to dischargeability of criminal fines and penalties in § 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 —
..+ (7) to the extent such debt is for a fine, penalty,
or forfeiture payable to and for the benefit of a gov-
ernmental unit, and is not compensation for actual
pecuniary loss, . . .
11 U.S.C. § 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 dis-
charged in a chapter 7 bankruptcy case are . . . [dJebts for most
fines, penalties, forfeitures, or criminal restitution obliga-
tions.”).
The Supreme Court explained the evolution of this excep-
tion to discharge in Kelly v. Robinson, 479 U.S. 40 (1986). In
that case, a defendant was ordered to pay restitution as a con-
dition 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 pay-
ments were not dischargeable under § 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 con-
clude 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
20a
restitution was discharged under § 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 sen-
tence. 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 condi-
tion 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 pur-
pose 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 restitu-
tion payments were not discharged under Chapter 7, such pay-
ments were dischargeable “debts” under Chapter 13. The
Court explained:
[I]n locating Congress’ policy choice regarding the
dischargeability of restitution orders in § 523(a)(7),
Kelly is faithful to the language and structure of the
Code: Congress defined “debt” broadly and took
Aya ChE bse
2la
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
§ 523(a)’s exceptions to discharge. ... Among those
exceptions that Congress chose not to extend to
Chapter 13 proceedings is § 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 balance Congress struck in
crafting the appropriate discharge exceptions for
Chapter 7 and Chapter 13 debtors.
495 USS. 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 penal-
ties. Under Chapter 7, that portion of a fine that is compensa-
tory is discharged. 11 U.S.C. § 523(7). See Davenport, 495 U.S.
at 559 (“The Court in Kelly analyzed the purposes of restitu-
tion in construing the qualifying clauses of § 523(a)(7), which
explicitly tie the application of that provision to the purpose of
the compensation required.”). We do not believe that Con-
gress intended for us to ignore the non-compensatory charac-
ter of a criminal fine in deciding if it is an administrative
expense under § 503, while explicitly requiring that consider-
ation under § 523(7). Rather, for the reasons previously stated,
we conclude that § 503’s restriction to “expenses of preserving
the estate” limits such expenses to those that constitute com-
pensation 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.
22a
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 criminal fines 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. 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 ten-
sion between our analysis here, and the analysis in N.P Min-
ing 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 regula-
tions were entitled to priority as an administrative expense
under Chapter 11. The holding was based upon the require-
ment in § 969(b) that the trustee or debtor in possession man-
age and operate the property in compliance with state law.
The court of appeals reasoned that
[i]f postpetition costs “ordinarily incident to opera-
tion 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
23a
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 ordi-
nary 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 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 crimi-
nal 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 Bank-
ruptcy 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 Biii’s Coal Com-
pany, 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).
Ill. 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 puni-
tive criminal fines arising from post-petition behavior are not
administrative expenses under 11 U.S.C. § 503(b), and there-
fore, are not accorded priority status pursuant to § 507(a)(1).
Therefore, the orders of the Bankruptcy Court and the Dis-
trict Court will be affirmed in accordance with this decision.
24a
No. 98-3332
Hnited States Court of Appeals
for the Third Circuit
COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF ENVIRONMENTAL RESOURCES,
Vv.
TRI-STATE CLINICAL LABORATORIES, INC.,
JOSEPH NIGRO, Trustee,
THE COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF ENVIRONMENTAL RESOURCES,
Appellant
ON APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
(D.C. No. 97-cv-02115)
District Judge: Honorable Donald J. Lee
ARGUED BY COUNSEL
January 26, 1999
Present: Sloviter, McKee and Rendell, Circuit Judges.
25a
JUDGMENT
This cause came on to be heard on the record from the
United States District Court for the Western District of Penn-
sylvania and was argued by counsel January 26, 1999.
On consideration whereof, it is now here ordered and
adjudged by this Court that the judgment of the said District
Court entered May 5, 1998, be, and the same is hereby
affirmed. Costs taxed against the appellants. All of the above
in accordance with the opinion of this Court.
ATTEST:
/s/ P. Douglas Sisk
Douglas Sisk
Clerk
Dated: June 2, 1999
26a
IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
COMMONWEALTH OF )
PENNSYLVANIA, DEPARTMENT )
OF ENVIRONMENTAL )
RESOURCES, )
) Civil Action No. 97-2115
) Bankruptcy Court
VS. ) No. 990-22476/JLC
TRI-STATE CLINICAL
LABORATORIES, INC.,
Appellant,
)
)
)
Appellee )
MEMORANDUM OPINION
May 5, 1998
Before the Court is the appeal of the Commonwealth of
Pennsylvania Department of Environmental Protection from
the final order of the United States Bankruptcy Court for the
Western District of Pennsylvania dated August 21, 1997, hold-
ing that a $20,000 criminal fine assessed for post-petition con-
duct is not an administrative claim under Section 503(b) of the
United States Bankruptcy Code, 11 U.S.C. § 503(b) and that
the claim shall be allowed as an unsecured claim.
On August 14, 1990, Tri-State Clinical Laboratories, Inc.
(“Debtor”) filed a voluntary petition under Chapter 11 of the
United States Bankruptcy Code. On January 21, 1992, a crimi-
nal complaint was filed against the Debtor for violation of
Pennsylvania Solid Waste Management Act. Count 1 of the
complaint accused the Debtor of unlawfully storing municipal
waste on or about July 18, 1990, and Count 2 charged that on
or about October 4, 1990, the Debtor disposed of infectious
waste in a municipal waste dumpster in violation of the Penn-
sylvania Solid Waste Management Act.
The Chapter 11 trustee, Joseph P. Nigro, was appointed
on September 10, 1992. On October 6, 1992, the case was con-
verted to Chapter 7 and again Joseph P. Nigro was appointed
Chapter 7 trustee on December 1, 1992.
PRM eae MAN aie ic ee eke inet
27a
On July 28, 1994, the Debtor was found guilty on both
counts of the criminal complaint before the Court of Common
Pleas of Westmoreland County. The Debtor ceased to operate
around August of 1991 and apparently the trustee was not
noticed as to the proceeding. However, the Debtor did appear
by counsel and either pled guilty or nolo contendere to both
counts, and the Court of Common Pleas of Westmoreland
County ordered the Debtor, and not the trustee, to pay the
criminal fine of $20,000 on Count 2 which is the claim at issue
here.
On June 1, 1994, the DER filed a motion for leave of
court to file a proof of claim beyond the bar date claiming that
it did not receive notice of the conversion to Chapter 7 and
the bar date, while the Bankruptcy Court found that the DER
had actual knowledge of the Debtor’s bankruptcy prior to the
conversion date, nevertheless, the court granted the motion on
August 9, 1994, because the trustee was not present during the
hearing to determine liability of the claim beyond the bar
date.
On August 19, 1994, the DER filed a proof of claim that
the fine of $20,000 is an administrative claim under Section
726(a)(1) of Section 507(a)(1) of the Code.
On April 1, 1997, the trustee filed an objection to the
proof of claim of the DER, alleging its administrative status.
It is noted that the trustee does not dispute status of the fine
as a subordinated unsecured claim under Section 726(a)(4) of
the Code.
On appeal, in addition to raising the issue of the adminis-
trative expense status of the criminal fine of $20,000, the DER
also appeals the holding of the Bankruptcy Court that its
order granting the DER leave to file its proof of claim beyond
the bar date was a nuility. This Court need not reach that
issue.
28a
Legal Discussion
On appeal from an order of the Bankruptcy Court, the
district court must apply the clearly erroneous test of factual
findings and plenary review to questions of law.
Moreover, mixed questions of law and fact must be
divided into the respective components and the appropriate
test applied. Jn re: Brown, 951 F.2d 564 (3d Cir. 1991).
After review of the record, the arguments and memo-
randa of the parties, the Court finds that the Bankruptcy
Court’s findings of fact are not clearly erroneous and the
Bankruptcy Court did not err with regard to the applicable
questions of law on the issue of the administrative status of
the criminal fine.
The Court finds it is not necessary to reach the issue of
whether the proper procedure for claiming the fine as admin-
istrative expense is to file a proof of claim for it, or to move
for its allowance as an administrative expense pursuant to 11
U.S.C. § 503(a).
Therefore, an appropriate order dismissing the appeal
will be entered.
Donald J. Lee, J.
29a
IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
COMMONWEALTH OF )
PENNSYLVANIA, DEPARTMENT )
OF ENVIRONMENTAL )
RESOURCES, )
) Civil Action No. 97-2115
aan ) Bankruptcy Court
VS. ) No. 990-22476/JLC
TRI-STATE CLINICAL )
LABORATORIES, INC.,
Appellee )
ORDER OF COURT
AND NOW, this Sth day of May, 1998, after hearing, it is
hereby
ORDERED that the appeal of the Commonwealth of
Pennsylvania Department of Environmental Resources is
DISMISSFD.
/s/ Donald J. Lee
Donald J. Lee
United States District Judge
cc Stuart M. Bliwas, Esquire
P.O. Box 8464
Bureau of Legal Services
Harrisburg, PA 17105-8464
Todd H. Crawford, Esquire
233 West Pittsburgh Street
P.O. Box 1142
Greensburg, PA 15601
Matthew M. Pavlovich, Esquire
Nigro and Malley
Two Gateway Center
Suite 1270
Pittsburgh, PA 15222
Clerk, U.S. Bankruptcy Court
Western District of PA
30a
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
IN RE: ) CASE NO. 90-22476 JLC
TRI-STATE CLINICAL ‘
LABORATORIES, INC., ) MOTION NO. N&M-12
Debtor, )
JOSEPH P. NIGRO, TRUSTEE, CHAPTER 7
Movant / Objector, )
y, ) OBJECTION TO CLAIM
) NO. 48
COMMONWEALTH OF )
PENNSYLVANIA, DEPARTMENT )
OF ENVIRONMENTAL RESOURCES )
Respondent / Claimant. )
MEMORANDUM OPINION
The matter before the court is Trustee Joseph P. Nigro
Movant/Objector’s objection to the proof of claim filed by
Respondent/Claimant the Commonwealth of Pennsylvania,
Department of Environmental Resources. The
Respondent/Claimant contends that a criminal fine assessed
postpetition should be given administrative expense status
under Section 503 (b) of the United States Bankruptcy Code.
For the reasons expressed below, the objection to proof of
claim shall be sustained.
FACTS
On August 14, 1990, Tri-State Clinical Laboratories, Inc.
(“Debtor”) filed a voluntary petition under Chapter 11 of the
United States Bankruptcy Code (“Code”). On January 21,
1992, a criminal complaint was filed against the Debtor for
violation of Pennsylvania’s Solid Waste Management Act.
Count I of the complaint accused the Debtor of unlawfully
storing municipal waste on or about July 18, 1990. Count II of
the criminal complaint stated that on or about October 4,
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1990, the Debtor disposed of infectious waste in a municipal
waste dumpster in violation of Pennsylvania’s Solid Waste
Management Act.
On September 10, 1992, Joseph P. Nigro was appointed
Chapter 11 trustee. On October 6, 1992, the case was con-
verted to Chapter 7 and again Joseph P. Nigro (“Trustee”) was
appointed the Chapter 7 Trustee on December 1, 1992. It
appears that on July 28, 1994, the Debtor was found guilty on
two counts of said violations before the Court of Common
Pleas of Westmoreland County by default. It is this court’s
understanding that the Debtor ceased to operate around
August of 1991. Nevertheless, the Trustee was not noticed as
to the proceeding. Consequently, the Debtor, not the Trustee,
was ordered by the Court of Common Pleas of Westmoreland
County to pay a criminal fine in the amount of $10,000.00 on
Count I and a criminal fine in the amount of $20,000.00 on
Count II.
On June 1, 1994, the Commonwealth of Pennsylvania
Department of Resources (“DER”) filed a motion for leave of
court to file proof of claim beyond the bar date claiming that
it did not receive the notice of conversion to Chapter 7 and
the bar date. The DER, however, had actual knowledge of the
Debtor’s bankruptcy prior to the conversion date. This is evi-
denced in its letter dated October 5, 1992 to then Chapter 11
Trustee Joseph P. Nigro which is attached as an exhibit to the
Trustee’s Response to the Motion to Allow Late Claim.
On August 9, 1994, this court granted the motion to allow
claim beyond the bar date as the Trustee, despite having filed
a written response, was not present during the hearing to
determine allowability of claim beyond the bar date.
On August 19, 1994, the DER filed a proof of claim which
states that the criminal fine of $ 10,000 assessed on Count I is
a subordinated unsecured claim under Section 726 (a) (4) of
the Code and the criminal fine of $20,000 imposed on Count
II is an administrative claim under Section 726 (a) (1) and
Section 507 (a) (1) of the Code.
On April 1, 1997, the Trustee filed an objection to the
proof of claim filed by the DER. Only the $20,000 portion of
the claim seeking administrative status for the criminal fine
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imposed is in dispute. The amount and priority of the $10,000
assessed on Count I are not disputed.
Discussion
DER’s Argument for Administrative Priority
The DER in arguing for administrative expense status of
the criminal fine, cites 11 U.S.C. Section 503 (b) (1) (A) which
provides that “the actual, necessary costs and expenses of pre-
serving the estate,” shall be allowed as an administrative
expense. The DER submits six cases in support of giving
administrative status to postpetition civil judgments, civil fines
and civil penalties. On this basis, it argues that the criminal
fine imposed postpetition for post petition activity of the
debtor should also be accorded administrative status.
The DER states two principles relating to administrative
status of postpetition tort claims which are set forth in Read-
ing Co. v. Brown, 391 US. 471, 88 S.Ct. 1759 (1968). First,
“tort claims arising during an arrangement are actual and nec-
essary expenses of the arrangement.” Jd. at 482, S.Ct. at 1765.
Second, there should be no distinction given in terms of prior-
ity “within the class of torts committed by receivers while act-
ing in furtherance of the business, between those ‘integral’ to
the business and those that are not.” Jd. at 485, S.Ct. at 1767.
The DER provides Jn re Charlesbank Laundry, Inc., 755
F.2d 200 (ist Cir. 1985), which extends the application of the
Reading’s rationale from civil judgment to civil fine. On this
point, the United States Court of Appeals for the First Circuit
held that since “fairness dictates that a tort claim based on
negligence should be paid ahead of pre-reorganization claims,
then, a fortiori, an intentional act which violates the law and
damages others should also be so treated.” Jd. at 203.
Additionally, DER submits In re N.P Mining Co. Inc.,
963 F.2d 1449 (11th Cir. 1992), to show that a civil penalty
assessed due to environmental violations incurred during
Chapter 11, which was later converted to Chapter 7 was
treated as an administrative priority. The United States Court
of Appeals for the Eleventh Circuit held that “the penalties in
question receive first priority, but only to the extent that they
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were incurred as a consequence of mining operations after the
bankruptcy petition was filed and while the business was still
operating.” Jd. at 1453. The N.P Mining court sets forth two
statutory reasons for its holding. First, under 28 U.S.C. Section
959 (b), trustees must operate an estate in compliance with
state law. Jd. at 1453. Second, the word “including” in Section
503 (b) indicates that Congress did intend that first priority
claims include claims other than those that serve to preserve
the estate. Jd. at 1456. Thus, the N.P Mining court has held,
that “in the regulated atmosphere of strip mining industry, a
fine for the violation of environmental regulations should be
considered a cost ordinarily incident to operation of a busi-
ness.” Jd. at 1458; See In re Bill’s Coal Co., Inc., 124 B.R. 827,
830 (D.Kan. 1991).!
The DER argues that there should be no distinction made
between civil fines and penalties because they are treated
identically under 11 U.S.C. Section 726 (a) (4).2 Accordingly,
the DER argues that there should be no distinction made
between a criminal fine and penalty. Therefore, the DER con-
tends that the $20,000 criminal fine imposed on the debtor
postpetition should be granted an administrative expenses
status.
Trustee’s Argument for Unsecured Status
The Trustee contends that the $20,000 criminal fine
should be treated as an unsecured claim under 11 U.S.C. Sec-
tion 726 (a) (4). He asserts that Congress has specifically
shown an intent to exclude the actual amount of criminal fines
1. DER offers two additional cases dealing, respectively, with civil pen-
alties and punitive fines in which they were both found to have administra-
tive priority. See In re Motel Investments. Inc., 172 B.R. 105 (Bankr. M.D.Fla.
1994) and In re Double B Distributors. Inc., 176 B.R. 271 (Bankr. M.D.Fia.
1994).
2. 11 U.S.C. Section 726 (a) (4) provides that property of the estate
shall be distributed “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 that such fine, penalty,
forfeiture, or damages are not compensation for actual pecuniary loss suf-
fered by the holder of such claim;”
: ERE SOE PORE INNO ENB —
34a
as administrative claims. The Trustee presents three primary
arguments in support of his contention. First, Section 503 (b)
(3) (C) limits administrative claims based upon criminal pros-
ecutions to “actual, necessary expenses incurred by a creditor
“in connection with the prosecution of a criminal offense
relating to the case or to the business or property of the
debtor.” Second, the language of the Code in Section 503 (b)
only mentions an exception to Section 503) (b) (3) (C) in the
context of taxes, which is provided for in Section 503 (b) (1)
(C). Third, Section 726 (a) (4) provides that administrative
expenses have priority over fines and penalties.
The Trustee contends that specific language of the Code
is controlling and to allow a criminal fine as an administrative
- expenses is contrary to the Congressional intent. The Trustee
claims that Congress has shown an intent to exclude the actual
amount of criminal fines from the ambit of administrative
expenses. Furthermore, the Trustee suggests that this court
should give consideration to the dissent in Reading who stated
that the theme of bankruptcy should follow “equality in distri-
bution, and if one claimant is to be preferred over others, the
purpose should be clear from the statute.” Reading Co, v.
Brown, 391 U.S. 471, 486, 88 S.Ct. 1759, 1767 (1968). Thus,
without clear language in the Code relating to criminal fines,
the Trustee argues that courts should not infer beyond what is
provided for in the Code.
The Trustee also points out that none of the cases that the
DER relies on have applicability to this case because they are
all decided in the context of a civil fine or civil penalty. Thus,
the Trustee argues that the case law cited by the DER is dis-
tinguishable and this court is not bound by those holdings.
Analysis on allowance of late claim
Prior to examining the merits of this matter, the court has
reviewed the procedural history of the claim.
This court finds that the DER filed an inappropriate
motion for its claim against the estate. Since the DER is claim-
ing administrative expense status for its judgment against the
Debtor, the DER’s motion should have been based on Section
503 which governs allowance of administrative expenses. On
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allowance of administrative expenses, Section 503 (a) provides
that “[aJn entity may timely file a request for payment of an
administrative expense or may tardily file such request if per-
mitted by the court for cause.” The DER, however, instead of
filing a motion to allow administrative expenses claim, filed an
improper motion (i.e. motion for leave of court to file proof of
claim beyond the bar date). Thus, this court’s order granting
the DER leave to file its proof of claim beyond the bar date
is, in effect, a nullity.
Additionally, even if the DER filed the proper motion
based on Section 503, this court finds for the reasons below
that the $20,000 criminal fine is not an administrative claim,
but an unsecured claim.
Analysis on administrative priority issue
The standard for allowing an administrative expense is set
forth in 11 U.S.C. Section 503 (b) (1) (A):
(b) After notice and a hearing, there 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 com-
mencement of the case....
The United States Supreme Court has held that “actual
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 Co. v.
Brown, 391 U.S. 471, 483, 88 S.Ct. 1759, 1766 (1968).
Therefore, pursuant to Section 503 (b) and the Reading
case, the pertinent issue to be decided here is whether a non-
compensatory criminal fine that is assessed postpetition is a
cost ordinarily incident to operation of a business within the
meaning of Section 503 (b).
Within the Third Circuit the issue of a claim under Sec-
tion 503 (b) has been addressed in the cases of Jn re Conroy.
144 B.R. 966 (Bankr. W.D.Pa. 1992), aff’d in part and rev’d in
part, 153 B.R. 686 (W.D.Pa. 1993), aff’d, 24 F.3d 568 (3d Cir.
1994).
36a
The facts of the Conroy case are as follows: The DER
ordered Conroy to remove the hazardous materials and he
failed to comply. Com. of Pa.. Dept. of Env. Resources v. Con-
roy 24 F.3d 568, 569 (3d Cir. 1994). Conroy filed a Chapter 11
petition in October 1990, and a few moonths later, the DER
engaged a private contractor who began to clean up the site.
Id. Two costs regarding this clean up were at issue as to
whether they should be given an administrative priority status:
(1) response costs; and (2) administrative and legal costs con-
cerning the clean up. /d.
In construing Section 503 (b) and administrative priority
status thereof, the United States Bankruptcy Court for the
Western District of Pennsylvania stated that “in order for an
expenditure to qualify as ‘actual’ and ‘necessary,’ it must ben-
efit the estate as a whole, not just the creditor/claimant.” Jn re
Conroy, 144 B.R. 966, 969 (Bankr. W.D.Pa. 1992). Addition-
ally, the court found that “[t]he terms ‘actual’ and ‘necessary’
in this context must be strictly construed.” Jd. Thus, as to
response costs, the court found that “[t]he bankruptcy estate
thereby was benefitted to the extent that action which was
required under the law — i.e. remediation — was performed
on its behalf by another party.” Jd. at 971. As to administra-
tive, and legal costs, however, the court found that such costs
go beyond the actual cost of remediating the problem and
found that such costs were arbitrary surcharges. /d.
The district court affirmed the analysis on response costs
but disagreed with the analysis on administrative and legal
costs. In re Conroy, 153 B.R. 686, 693 (W.D.Pa. 1993). The
district court found that “[t]he Supreme Court has not con-
strued the meaning of administrative expenses narrowly,” and
also determined that the analysis on administrative and legal
costs by the bankruptcy court “ignores that there are other
policies also involved in Section 503 (b).” In re Conroy, 153
B.R. 686, 691 (W.D.Pa. 1993); See also Reading Co. v. Brown,
391 U.S. 471, 484-485, 88 S.Ct. 1759, 1766, In-re N.P. Mining
Co. Inc., 963 F.2d 1449, 1454. As to the other policies, the dis-
trict court in Conroy cites 28 U.S.C. Section 959 (b) which
mandates that a trustee follow the state law including the law
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that provides for recovery of administrative and legal costs.3
Id. at 692. Thus, the court found that “the bankruptcy court
applied an incorrect legal standard in denying DER’s request
for a [administrative and legal] costs pursuant to [Pennsylva-
nia statute dealing with recovery of administrative and legal
costs].” Jd.
Additionally, the court held that these additional costs
“represents real and actual administrative and legal costs
incurred by DER.” Jd. The court, however, qualified its hold-
ing by stating that the administrative and legal costs in this
case are “compensatory in nature.” Jd. at 692, n.2. As to hypo-
thetical non-compensatory costs, the court did not offer a
guideline but suggested that awarding a non-compensatory
costs would conflict with the established doctrine of adminis-
trative expense status for environmental clean up costs. Jd. at
692, n.2; See generally In re N.P. Mining Co. Inc., 963 F.2d
1449, 1458 (11th Cir. 1992) (stating that a fine need not be a
compensatory one).
On appeal, the Third Circuit did not address on the non-
compensatory costs issue and affirmed on the grounds that the
administrative and the legal costs along with the response cost
were compensation for actual and necessary expenses for pre-
serving the estate under Section 503 (b). Com. of Pa.. Dept. of
Env. Resources v. Conroy, 24 F.3d 568, 570-571 (3d Cir. 1994)
The Third Circuit court in Conroy had two grounds on which
to affirm the district court, 28 U.S.C. Section 959 (b) and 11
U.S.C. Section 503 (b).4 The decision was affirmed, however,
only on the basis of Section 503 (b).
3. Title 28 U.S.C. Section 959 (b) provides that “...a trustee... appointed
in any cause pending in any court of the United States, including a debtor in
possession, shall manage and operate the property in his possession as such
trustee, ... according to the requirements of the valid laws of the State in
which such property is situated, in the same manner that the owner or pos-
sessor thereof would be bound to do if in possession thereof.”
4. Although the district court in Conroy did not cite Section 503 (b) for
its holding on the associated administrative and legal costs, this court takes
the district court's holding that such costs were “real and actual administra-
tive and legal costs incurred by DER” to be adequate to determine that the
holding was based on Section 503 (b). See In re Conroy, 153 B.R. 686, 692.
38a
The Third Circuit court’s apparent reluctance to base its
holding on Section 959 (b) is evidenced in the following
holding.
[W]e think that the amount of the award in this case
... was sufficiently substantiated ... [T]he Pennsyl-
vania legislature apparently concluded that the
DER’s ‘administrative and legal costs’ will generally
amount to 10% of the amount paid for the response
action or the actual costs, whichever is greater. This
implicit legislative Finding is reasonable, and we
believe that it is sufficient to satisfy the DER’s bur-
den of proving its entitlement to these administra-
tive expenses. While the Conroys and other inter-
ested parties could certainly have attempted to show
that the 10% figure was excessive in this case, the
Conroys have not directed our attention to any such
evidence. Moreover, there is evidence in the record
that tends to substantiate the reasonableness of the
amount awarded.
Id. at 571.
The Third Circuit could have held that Conroy must pay
as an administrative expense pursuant to Section 959 (b)
regardless of whether or not the DER could reasonably sub-
stantiate its administrative and legal costs. The Third Circuit
court, however, suggested that Conroy had an opportunity to
rebut the statutory presumption by showing that the costs
were excessive. In other words, the Third Circuit court seems
to indicate in its holding a willingness to disallow the DER’s
claims to the extent that the claim is non-compensatory.
Therefore, it is inferred from this case that the Third Circuit
based its decision on Section 503 (b) because a compensatory
and non-compensatory distinction comports with the statutory
language of Section 503 (b) that “the actual, necessary costs
and expenses of preserving the estate” shall be allowed as
administrative expenses.
In the instant case, there was no governmental action to
clean up the waste produced by the Debtor even though the
39a
DER fully knew of the location of the waste. Instead, the
DER fined the Debtor an amount that has no connection with
the clean up costs. Had this been a cost directly associated
with the environmental remediation, it would clearly be a
compensatory cost within the context of Conroy. As a crimi-
nal fine which has no association with the actual cleanup costs,
however, It is strictly a non-compensatory expense.
Therefore, this court holds that the criminal fine which is
not associated with the clean up costs is not an administrative
claim under Section 503 (b) based on the Third Circuit’s hold-
ing in Conroy. Id. at 571.
Section 503 (b) gives consideration to the Statutory objec-
tive that was decisive in the Reading court's holding: “fairness
to all persons having claims against the insolvent.” 391 U.S.
471, 477, 88 S.Ct. 1759, 1763 (1968). Pursuant to such objec-
tive, the Reading court analyzes the positions of the victims of
the negligence of the receiver and creditors and concludes that
“the present [claimant] did not merely suffer injury at the
hands of an insolvent business: it had an insolvent business
thrust upon it by operation of law.” Jd. a at 478, 88 S.Ct. 1763.
In furtherance of that the Reading court finds as follows:
The “master,” liable for the negligence of the “ser-
vant” in this case was the business operating under
a Chapter XI arrangement for the benefit of credi-
tors and with the hope of rehabilitation. That ben-
efit and that rehabilitation are worthy objectives.
But it would be inconsistent both with the principle
of respondent 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 is instituted.
Id. at 479, 88 S.Ct. 1764.
Only after this “fairness” analysis, the Reading court
reaches the holding that “actual and necessary cost should
include costs ordinarily incident to operation of a business,
40a
and not be limited to costs without which rehabilitation is
impossible.” Jd. at 484, 88 S.Ct. at 1766.
Debtors in possession and trustees are required to obey
the laws during the administration of the case. When they fail
by ignorance or deliberate willfulness, the consequence
requires careful analysis. 11 U.S.C. Section 503 (b) requires
the administrative expenses to benefit the estate by being nec-
essary and actual. Breaking the law regarding disposal of
waste is not necessary for the administration of the estate and
the criminal fines an not actual expenses related to specific
cleanup. Government environmental agencies such as ASMC
(the Alabama Surface Mining Commission, the appellant in
N.P. Mining) and the DER are not helpless parties who had
insolvent businesses thrust upon them by operation of law.
Rather they are in a better position than the Chapter 11 credi-
tors to monitor and prevent environmental violations because
(1) they have police power to enforce the statutory environ-
mental requirement; and (2) they are in a position to protect
their interest through legislation.
Thus, this court finds that a compensatory and non-
compensatory distinction is appropriate in determining
whether a claim should be accorded an administrative status in
an environmental cleanup case under Section 503 (b). The
criminal fine imposed did not go toward compensating DER
for any administrative, legal or other costs directly associated
with any environmental remediation. Creditors should not be
forced to bear this burden, particularly when the expense is
non-compensatory and does not benefit the estate. The court
must encourage the collection of assets and the maximization
of distribution to all creditors. The use of the criminal law to
discourage the offenses by fines has wide discretion. To clas-
sify these as administrative expenses discourages the collec-
tion of assets and reduces distribution to all creditors.
4la
Conclusion
For the reasons expressed above, this court finds that the
criminal fine assessed postpetition for postpetition conduct is
not an administrative expense under Section 503) (b). Accord-
ingly, the Trustee’s objection to proof of claim is sustained.
An appropriate order shall be entered.
On this 21st day of August, 1997
At Pittsburgh, Pennsylvania
/s/ Joseph L. Cosetti
Joseph L. Cosetti
U.S. Bankruptcy Judge
cc: MATTHEW M. POVLOVICH, ESQUIRE
Nigro & Malley
Two Gateway Center, Suite 1270
Pittsburgh, PA 15222
STUART M. BLIWAS, ESQUIRE
PA Dept of Environmental Protection
400 Market Street, P.O. Box 8464
Harrisburg, PA 17105-8464
42a
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
IN RE: ) CASE NO. 90-22476 JLC
)
TRI-STATE CLINICAL
COMMONWEALTH OF
PENNSYLVANIA, DEPARTMENT
OF ENVIRONMENTAL RESOURCES )
LABORATORIES, INC., MOTION NO. N&M-12
Debtor, )
JOSEPH P. NIGRO, TRUSTEE, CHAPTER 7
Movant / Objector, _)
¥ ) OBJECTION TO CLAIM
) NO. 48
)
)
Respondent / Claimant.)
ORDER OF COURT
AND NOW this 21st day of August, 1997, for the reasons
expressed in the Memorandum Opinion of the same date, it is
ORDERED, ADJUDGED and DECREED that the $20,000
criminal fine assessed for postpetition conduct is not an
administrative claim under Section 503 (b) of the the United
States Bankruptcy Code and the claim shall be allowed as an
unsecured claim.
/s/ Joseph L. Cosetti
Joseph L. Cosetti
U.S. Bankruptcy Judge
cc: MATTHEW M. POVLOVICH, ESQUIRE
Nigro & Malley
Two Gateway Center, Suite 1270
Pittsburgh, PA 15222
STUART M. BLIWAS, ESQUIRE
PA Dept of Environmental Protection
400 Market Street, P.O. Box 8464
Harrisburg, PA 17105-8464
43a
No. 98-3332
United States Court of Appeals
for the Chird Circuit
sa COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF ENVIRONMENTAL RESOURCES,
Appellants,
V.
TRI-STATE CLINICAL LABORATORIES, INC.,
JOSEPH NIGRO, Trustee,
Appellees.
SUR PETITION FOR REHEARING
Present: BECKER, CHIEF JUDGE,
SLOVITER, MANSMANN, GREENBERG, SCIRICA,
NYGAARD, ALITO, ROTH, McKEE and RENDELL
Circuit Judges.
The petition for rehearing filed by Appellant's in the
above entitled case having been submitted to the judges who
participated in the decision of this court and to all other avail-
able circuit judges of the circuit in regular active service, and
no judge who concurred in the decision having asked for
rehearing, and a majority of the circuit judges of the circuit in
regular active service not having voted for rehearing by the
court in banc, the petition for rehearing is denied.
BY THE COURT,
/s/ Theodore A. McKee
Circuit Judge
Hon. Theodore A. McKee
July 21, 1999
11 U.S.C. § 503
(b) After notice and a hearing, there shall be allowed admin-
istrative expenses, other than claims allowed under sec-
tion 502(f) of this title, including —
(1)(A) the actual, necessary costs and expenses of pre-
serving the estate, including wages, salaries, or commis-
sions for services rendered after the commencement of
the case;
(B) any tax —
(i) incurred by the estate, except a tax of a kind speci-
fied in section 507(a)(7)(8) of this title; or
(ii) attributable to an excessive allowance of a tenta-
tive carryback adjustment that the estate received,
whether the taxable year to which such adjustment
relates ended before or after the commencement of
the case; and
(C) any fine, penalty, or reduction in credit relating to a
tax of a kind specified in subparagraph (B) of this
paragraph;
(2) compensation and reimbursement awarded under section
330(a) of this title;
(3) the actual, necessary expenses, other than compensation
and reimbursement specified in paragraph (4) of this sub-
section, incurred by
(A) a creditor that files a petition under section 303 of
this title:
(B) a creditor that recovers, after the court’s approval,
for the benefit of the estate any property transferred
or concealed by the debtor:
(C) a creditor in connection with the prosecution of a
criminal offense relating to the case or to the busi-
ness or property of the debtor
(D) a creditor, an indenture trustee, an equity security
holder, or a committee representing creditors or
equity security holders other than a committee
appointed under section 1102 of this title, in making
a substantial contribution in a case under chapter 9
or 11 of this title;
(4)
(5)
(6)
45a
(E) a custodian superseded under section 543 of this title,
and compensation for the services of such custodian;
or
(F) a member of a committee appointed under section
1102 of this title, if such expenses are incurred in the
performance of the duties of such committee:
reasonable compensation for professional services ren-
dered by an attorney or an accountant of an entity whose
expense is allowable under paragraph (3) of this subsec-
tion, based on the time, the nature, the extent, and the
value of such services, and the cost of comparable services
other than in a case under this title, and reimbursement
for actual, necessary expenses incurred by such attorney
or accountant;
reasonable compensation for services rendered by an
indenture trustee in making a substantial contribution in a
case under chapter 9 or 11 of this title, based on the time,
the nature, the extent, and the value of such services, and
the cost of comparable services other than in a case under
this title; and
the fees and mileage payable under chapter 119 of the title
28 [28 U.S.C. §§ 1821 et. seq.].
Former Bankruptcy Act —
§ 57(j), 11 U.S.C. § 93 (j) (repealed 1978):
Debts owing to the United States or to any State or any
subdivision thereof as a penalty or forfeiture shall not be
allowed, except for the amount of the pecuniary loss sus-
tained by the act, transaction, or proceeding out of which
the penalty or forfeiture arose, with reasonable and actual
costs occasioned thereby and such interest as may have
accrued on the amount of such loss according to law.
§ 64a(I), 11 U.S.C. § 104(a)(1) (repealed):
a. 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 to filing the petition.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.