Reply Brief — Zurich American Insurance v. Lexington Coal Co., 129 S. Ct. 2866 (2009) (No. 08-1254)

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ye So, FILED

| No. -1254 JUN : i 2009

OFFICE OF THE CLERK

IN THE SUPREME COURT, U.S.

Supreme Court of the United States

ZURICH AMERICAN INSURANCE COMPANY,

Petitioner,

LEXINGTON COAL COMPANY, LLG, -

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

REPLY BRIEF IN SUPPORT OF

PETITION FOR A WRIT OF CERTIORARI

KAREN LEE TURNER SETH P. WAXMAN

ECKERT, SEAMANS, Counsel of Record

CHERIN & MELLOTT, LLC CRAIG GOLDBLATT

Two Liberty Place DANIELLE SPINELLI

50 South 16th Street WILMER CUTLER PICKERING

Philadelphia, PA 19102 HALE AND DORR LLP

(215) 851-8400 1875 Pennsylvania Ave. NW

Washington, DC 20006

(202) 663-6000

JAMES H. MILLAR

JANET R. CARTER

WILMER CUTLER PICKERING

HALE AND DORR LLP

399 Park Avenue

New York, NY 10022

(212) 230-8800

TABLE OF CONTENTS

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I. THE COURTS OF APPEALS ARE DIVIDED

ON WHETHER FUTURE OBLIGATIONS ARIS-

ING FROM A DEBTOR’S CONDUCT DURING

BANKRUPTCY ARE ADMINISTRATIVE EX-

Il. THIS CASE IS AN APPROPRIATE VEHICLE

FOR RESOLVING THE ENTRENCHED SPLIT

OF AUTHORITY REGARDING WHEN A

BANERUPTCY CLATM ARIGES .onnn.ncccncccncccecccnccseessssseee 8

III. THE DECISION BELOW WRONGLY RE-

SOLVES AN IMPORTANT ISSUE AND WAR-

RANTS IMMEDIATE REVIEW...........-.cc-ccceeccececceceeccceeee 10

Se UII cecil cetisccaac ececakelancseninenNccSlcs wenbnlansbanatinanni 13

(i)

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TABLE OF AUTHORITIES

CASES

Page(s)

CPT Holdings, Inc. v. Industrial & Allied

Employees Union Pension Plan, 162 F.3d

BAG CGA SA Dieta ctaantntinnccsrccececcccese 10

In re H.L.S. Energy Co., 151 F.3d 434 (5th Cir.

19QG) uccscnccineenniaesiaeeaiiealaaeaiaiiaainlaniaabteniaviescescosuccees 10

In re Hemingway Transport, Inc., 993 F.2d 915

Rat, Cale Re acetic ernie titers ereeseccee 3, 4,5

In re Klein Sleep Products, Inc., 78 F.3d 18 (2d

Ce. FB iicscttiea eee itaaiileaisabiiniteniiieiiatiniieiencere 3, 5, 6, 7

In re M. Frenville Co., 744 F.2d 332 (8d Cir.

ROE) ic scissceassmn aaa intalintiirninctitinecnevcscerccere 10

In re Merry-Go-Round Enterprises, Inc., 180

ee ee 3, 5, 6, 7

In re Stewart Foods, Inc., 64 F.3d 141 (4th Cir.

BGG sciccecacnspisee nan a ceidipneenicincrsoresesccovers 7

In re Sunarhauserman, Inc., 126 F.3d 811 (6th

ar. rac irieineiicnccccceccoccee 9

Reading Co. v. Brown, 391 U.S. 471 (1968) ........... 1,2, 10

STATUTES

Coal, Tine, Come Br a etieicteeetiicdcccrnncnees 11

11 U.S.C.

5, 5 NE TRIO 8 EO A A 8,9

ERR en SEES ano 12

IN THE

Supreme Court of the United States

No. 08-1254

ZURICH AMERICAN INSURANCE COMPANY,

Petitiones.

Vv.

LEXINGTON COAL COMPANY, LLC,

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

REPLY BRIEF IN SUPPORT OF

PETITION FOR A WRIT OF CERTIORARI

Before the decision below, it was settled law that

when a creditor provides goods or services to a debtor

in bankruptcy, its claim for payment is entitled to ad-

ministrative-expense priority. As this Court held in

Reading Co. v. Brown, 391 U.S. 471, 483 (1968), costs

“ordinarily incident to operation of {the debtor’s] busi-

ness” receive administrative priority. That priority is

critical: without it, parties would be unwilling to risk

dealing with debtors. And without the goods, services,

and credit necessary to operate their businesses during

bankruptcy, debtors would be unable to reorganize, or

even liquidate in an orderly fashion—frustrating the

basic purpose of bankruptcy and harming debtors and

creditors alike.

The lower court acknowledged that the insurance

Zurich provided “was critical to the Debtors’ opera-

tions. Without [it], the Debtors would have been un-

able to operate their bwsinessj.]” Pet. App. 10a-1la.

Yet it held that the deductibies the debtor was contrac-

tually obligated to pay for that insurance—obligations

the court found “will inevitably arise” and “reach well

into the millions of dollars,” 7d. 28a n.17—were not ad-

ministrative expenses. It reasoned that because the

deductibles would not come due until after the debtor’s

liquidation, their payment would not benefit the estate.

Id. 27a, 33a. Accordingly, it concluded, Zurich could not

recover for the deductibles in bankruptcy, but only

from the post-liquidation debtor—a “right to recover

[that] exists in theory but is not enforceable in prac-

tice.” Reading, 391 US. at 478.

That reasoning cannot be reconciled with Reading’s

core holding: in evaluating whether a claim warrants

administrative priority, the question is not whether

payment of the claim would benefit the estate, but

whether the claim stems from the debtor’s operations

during bankruptcy. And it is in square conflict with de-

cisions of other courts of appeals recognizing that all

obligations relating to a debtors operations during

bankruptcy are entitled to administrative priority, even

if the debtor liquidates before those obligations would

otherwise mature. The Sixth Circuit’s conclusion that

Zurich’s claim for deductibles would not arise until af-

ter the debtor’s liquidation, when it would mature un-

der state law, likewise conflicts with decisions of other

courts of appeals holding that unmatured claims—

including contract claims—are nonetheless claims enti-

tled to payment in bankruptcy.

Respondent Lexington attempts to distract atten-

tion from these important legal questions by repeatedly

sounding two themes: that this case is a mere contract

dispute controlled by the terms of the insurance poli-

cies; and that the issue presented is “narrow,” “rare,”

“unique,” and limited to these specific facts. Each of

these contentions is wrong. This case does not present

a question of contract law, but a question of bankruptcy

law: whether obligations arising from the debtor’s con-

duct during bankruptcy, but maturing only later, are

nonetheless claims in bankruptcy entitled to adminis-

trative priority. And, far from being limited to the .

facts of this case, this question arises in a wide variety

of circumstances—including, for example, on-going en-

vironmental obligations arising from the debtor’s op-

erations in bankruptcy. See State Amici Br. 18-19.

As the amici demonstrate, the questions presented

here are critically u:»ortant to creditors, shareholders,

and employees of companies in bankruptcy—as well as

those companies themselves. In light of the nation’s

economic crisis and the wave of bankruptcies of major

corporations that has already begun, this Court should

resolve these issues now.

I. THE COURTS OF APPEALS ARE DIVIDED ON WHETHER

FUTURE OBLIGATIONS ARISING FROM A DEBTOR’S

CONDUCT DURING BANKRUPTCY ARE ADMINISTRATIVE

EXPENSES

Zurich’s petition demonstrated that the decision

below squarely conflicted with decisions of the First,

Second, and Fourth Circuits: In re Hemingway Trans-

port, Inc., 993 F.2d 915 (1st Cir. 1993); In re Klein Sleep

Products, Inc., 78 F.3d 18 (2d Cir. 1996); In re Merry-

Go-Round Enterprises, Inc., 180 F.3d 149 (4h Cir.

1999). Lexington attempts to distinguish these cases

by arguing that they arose on different facts. That is

irrelevant. Each case presents the same legal question:

whether obligations arising from the debtor’s opera-

tions during bankruptcy are entitled to administrative

priority even if the debtor liquidates before those obli-

gations would otherwise come due. And each reaches a

result that cannot be reconciled with the Sixth Circuit’s

holding here.

Lexington first argues (Opp. 12-13) that Heming-

way considered “post-confirmation obligations in con-

nection with environmental obligations under CER-

CLA,” and “[tjhis case has nothing to do with CER-

CLA liability.” To be sure. But Lexington does not

dispute the key points that put Hemingway squarely in

conflict with the decision below: The claimant there,

Juniper, which purchased contaminated property from

the debtor during its bankruptcy, sought administra-

tive-expense priority for environmental clean-up costs

that would come due, if at all, only after confirmation,

that it might never incur, and whose amount was un-

certain. The First Circuit rejected the argument that

administrative priority was unavailable because future

clean-up would not benefit the estate, holding that the

proper inquiry was whether the consideration received

from Juniper (the contaminated property’s purchase

price) benefited the estate. And it granted administra-

tive priority to the estimated future clean-up costs. 993

F.2d at 929-930, 934. There can be no doubt that Zurich

would have prevailed under this analysis.

Lexington’s only other attempt to distinguish He-

mingway is to quote a passage from that decision—

“C{ojnly ‘actual’ administrative expenses, not contingent

expenses, are entitled to priority payment under ...

§503(b)(1)(A),” 993 F.2d at 930—that Lexington con-

tends (Opp. 13-14) supports the Sixth Circuit’s conclu-

sion that future payment obligations cannot be adminis-

trative expenses.

Lexington misunderstands that passage, which, as

its context makes clear, addresses an entirely different

issue. Under CERCLA, both the debtor and Juniper

were potentially liable for clean-up costs. The First

Circuit thus had to determine whether Juniper’s claim

for future clean-up costs should be disallowed under

§502(e)(1)(B), which (to avoid double recovery) requires

disallowance of contingent contribution claims by enti-

ties that are co-liable with the debtor. If Juniper were

co-liable with the debtor under CERCLA, its “contin-

gent” claim for future clean-up costs could not be al-

lowed. The passage on which Lexington relies simply

clarifies that the §502(e)(1)(B) limitation on allowance

of “contingent” claims applies to administrative ex-

penses as well as pre-petition claims.

But the First Circuit made perfectly clear that if

Juniper surmounted §502(e)(1)(B) by proving that it

was not co-liable with the debtor, its claim for future

¢lean- -up costs would receive administrative priority

despite being “contingent.” The court’s holding is un-

mistakable: if §502(e)(1)(B) does not apply, Juniper’s

“claim for past and future response costs should be es-

timated and allowed as administrative expenses enti-

tled to priority.” 993 F.2d at 934 (emphasis added); see

id. at 936. The Sixth Circuit’s decision is in direct con-

flict with that holding.

Lexington similarly attempts (Opp. 15-16) to limit

Klein Sleep and Merry-Go-Round to their facts, argu-

ing that each turned on an express contractual provi-

sion for acceleration of future rent obligations in case of

breach. Initially, Klein Sleep nowhere indicates that

the lease there contained any such provision. More

fundamentally, neither decision focused its analysis on

the lease’s terms or framed the question as one of con-

tract law. Rather, each stands for the proposition that,

when the debtor enters a contract during bankruptcy,

“all liability under the [contract]” is an administrative

expense. Klein Sleep, 78 F.3d at 22.

Indeed, both Klein Sleep and Merry-Go-Round re-

jected the precise arguments Lexington advanced, and

the lower court adopted, here. In Klein Sleep, the trus-

tee contended that after the debtor decided to liquidate

and the trustee surrendered the premises, the estate

derived no benefit from the lease, and future rent thus

was not an administrative expense. That argument,

the Second Circuit explained, “relies on an unduly nar-

row view of the benefit conferred on an estate when a

trustee assumes” a contract. 78 F.3d at 24. Because

the lease was assumed during bankruptcy and the

debtor enjoyed its benefits before liquidating, the land-

lord was entitled to administrative priority for all lease

obligations.

Merry-Go-Round similarly held that future rent

under a lease assumed and then repudiated following a

decision to liquidate was an administrative expense. It

reasoned that the expense was “actual” because it

“arose out of a post-petition transaction” with the

debtor, and “necessary” because the lease benefited the

debtor before liquidation. 180 F.3d at 157-158. “If land-

lords ... are not guaranteed to receive ... administra-

tive priority on future rent, then they would have little

incentive” to do business with debtors. /d. at 158. Far

from being limited to its facts, the court explained, “this

same argument could be equally applied to any other ...

executory contract.” Id.

This case is no different from Klein Sleep and

Merry-Go-Round. Here, as there, the debtor assumed

a contract necessary to continue its business in bank-

ruptcy. Here, as there, the reorganization failed and

the debtor liquidated, leaving it unable to fulfill its con-

tractual obligations. Here, as there, the contract none-

theless conferred an unmistakable benefit upon the

debtor’s estate, and—under the reasoning of the Sec-

ond and Fourth Circuits—all liability under the con-

tract is thus entitled to administrative priority.

Ultimately, Lexington’s arguments reduce to one

mistaken assertion: that a claim’s allowability and pri-

ority are controlled by the contract’s terms, and that

Zurich could not “accelerate” the date the deductibles

would come due under the policies by asserting a claim

for those deductibles in bankruptcy. That contention

reflects a thoroughgoing misunderstanding of how

bankruptcy works. Because bankruptcy’s purpose is to

distribute a limited estate among all identifiable credi-

tors, most courts of appeals treat unmatured or contin-

gent payment obligations, including obligations under a

contract, as claims in bankruptcy. See, e.g., In re Stew-

art Foods, Inc., 64 F.3d 141, 144 (4th Cir. 1995) (a credi-

tor’s pre-petition claim for future payments under a

contract “is not defeated simply because his right to the

individual payments had not yet become due as of the

date of the bankruptcy filing”); Pet. 21-29. That is not

an improper “acceleration” of the contract’s payment

terms, but simply a function of bankruptcy’s require-

ment that all claims be liquidated by a date certain.

The question here is whether administrative ex-

penses—which are merely post-petition claims—should

be treated any differently. The First, Second, and

Fourth Circuits have concluded that they should not be,

and that all obligations stemming from a debtor’s con-

duct during bankruptcy, including future-arising obli-

gations, are administrative expenses. The Sixth Cir-

cuit’s holding cannot be reconciled with those decisions.

Il. THis CASE IS AN APPROPRIATE VEHICLE FOR RESOLV-

ING THE ENTRENCHED SPLIT OF AUTHORITY REGARD-

ING WHEN A BANKRUPTCY CLAIM ARISES

As Zurich’s petition demonstrated, the courts of

appeals are in disarray regarding one of the most basic

questions in bankruptcy: when a “claim” arises that

can be asserted—and potentially discharged—in bank-

ruptcy. By holding that Zurich could not recover for

future deductibles in the bankruptcy, but could proceed

only against “the dissolved estate,” Pet. App. 24a, the

court below concluded that Zurich’s claim would arise

only after the bankruptcy, when a right to payment

would accrue under state law. See also id. 33a-34a; Pet.

21-22. In doing so, it adopted the minority position pre-

viously endorsed by the Third Circuit, and exacerbated

the existing split of authority.

Lexington readily acknowledges (Opp. 21-22) the

long-standing and entrenched division of authority on

this critical issue of bankruptcy law. And it does not

deny that the lower court held that Zurich’s claim

would arise only post-bankruptcy—indeed, it endorses

that position. Opp. 32 (“{T]he obligation to reimburse

the deductibles will not even arise by contract until [af-

ter confirmation]. Claims incurred post-confirmation

are simply ordinary creditor claims against the post-

confirmation debtor.”). Instead, Lexington contends—

in an argument spanning many pages, but ultimately

reducing to a single point—that the split is not impli-

cated here because it involves only the construction of

§101(5), which defines “claim” to include “unmatured”

and “contingent” rights to payment. To receive admin-

istrative priority, Lexington argues, a claim cannot be

unmatured or contingent.

Lexington’s contention that the split is not impli-

cated is simply wrong. The court below did not hold

that Zurich had a claim in bankruptcy while denying

that claim administrative priority; rather, it held that

Zurich would have a claim only after bankruptcy,

against the “dissolved estate.” Pet. App. 24a. It thus

took sides in the split regarding when a claim arises.

Even if the court had held only that unmatured ob-

ligations cannot be administrative expenses, however,

this case would still implicate that split. Administra-

tive expenses are simply claims that arise during bank-

ruptcy. Pet. 22-23. And, as discussed in Part I, other

courts have held—contrary to Lexington’s position—

that administrative expenses include unmatured obli-

gations arising during bankruptcy. If those courts are

correct, this case presents the question whether Zu-

rich’s claim for future deductibles arose, and could thus

be asserted as a priority claim, during bankruptcy. If

they are not correct, this case still presents the ques-

tion whether Zurich could assert a non-priority claim in

bankruptcy. In short, it makes no difference that this

case involves an administrative-priority claim: to have

an administrative claim, Zurich must first have a claim

under §101(5). This case thus enables this Court to re-

solve the question that has long divided the courts of

appeals: when a claim—be it a pre-petition claim or a

post-petition administrative claim—arises under the

Bankruptcy Code.'

: Lexington also points (Opp. 23-24) to another Sixth Circuit

case, In re Sunarhauserman, Inc., 126 F.3d 811, 818 (6th Cir.

1997), that contains a sentence that could be read to reject the

Ill. THE DECISION BELOW WRONGLY RESOLVES AN IM-

PORTANT ISSUE AND WARRANTS IMMEDIATE REVIEW

The Sixth Circuit’s decision is a dramatic departure

from the basic principles set out by this Court. As

Reading held, administrative expenses—the “ ‘actual

and necessary costs’” of preserving the estate—include

all “costs ordinarily incident to operation of a business.”

391 U.S. at 483. The deductibles here are the debtor’s

payment for insurance necessary for its business. Un-

der Reading, those obligations are entitled to adminis-

trative priority.

Lexington argues (Opp. 17) that Reading is rele-

vant only to “a select group of difficult to classify

claims,” and has no bearing on contract claims. That is

untenable: Reading construed the administrative-

priority statute in light of basic bankruptcy purposes.

391 U.S. at 475-476. That construction governs all ad-

ministrative expenses, not some “select group.” And it

refutes the lower court’s conclusion that the deductible

obligations conferred no “benefit” on the estate; the

state-mandated insurance unquestionably conferred a

benefit by permitting the business to operate. See id.

at 488; see also, e.g., In re H.L.S. Energy Co., 151 F.3d

434, 437-439 (5th Cir. 1998) (satisfying obligation to

plug unproductive oil wells “benefited” estate by per-

mitting operation of business in accord with state law).

state-law accrual theory. But as the petition explained (Pet. 25

n.9), that sentence, which did not discuss Jn re M. Frenville Co.,

744 F.2d 332 (3d Cir. 1984), or any other decision in the split, has

been disregarded by subsequent Sixth Circuit decisions—the deci-

sion below and CPT Holdings, Inc. v. Industrial & Allied Em-

ployees Union Pension Plan, 162 F.3d 405 (6th Cir. 1998), which

have expressly or implicitly endorsed the Third Circuit’s Frenville

line of authority.

Moreover, the Sixth Circuit’s incorrect decision will

have serious and broad repercussions. As the State

amici demonstrate, it threatens to disrupt the sound

operation of bankruptcy law at precisely the time when

our nation’s economy depends on its smooth function-

ing. Insurers will be unwilling to offer low-cost de-

ductible policies, endangering debtors’ ability to obtain

necessary insurance. More generally, lenders and ven-

dors will hesitate to deal with debtors if all obligations

arising from those dealings will not receive priority.

Lexington attempts to blunt the impact of the

Sixth Circuit’s misguided decision by repeatedly claim-

ing that the issue presented is “narrow” and “rare.”

Not so. Initially, Lexington is wrong that the policy

here, under which the insurer advances deductibles, is

“unique.” Opp. i. It is, in fact, a common arrangement

when the insured is a company rather than an individ-

ual. Indeed, some states require such an arrangement

for workers’ compensation insurance. See Cal. Ins.

Code §11735(e)(3). Moreover, as the State amici ex-

plain (Br. 17), the same issues arise with respect to self-

insured companies, which include such large companies

as Chrysler and General Motors, both now in bank-

ruptcy. When such companies become insolvent, state

funds pay injured workers and assert claims in bank-

ruptcy. If such claims did not receive administrative

priority, many state funds would face insolvency them-

selves.

More broadly, on the Sixth Circuit’s view, any ven-

dor providing goods or services to a debtor while re-

quiring payment in the future would risk going unpaid

if the debtor liquidates before payment would other-

wise come due. And, as the State amici explain (Br. 18-

19), the same legal question arises in scenarios involv-

ing involuntary creditors, such as environmental clean-

up costs that result from a debtor’s operations in bank-

ruptcy, but continue after the bankruptcy’s conclusion.

Under the Sixth Circuit’s reasoning, States (or the

EPA) could never recover in bankruptcy for such fu-

ture clean-up costs, and if the debtor liquidates, would

have no effective recourse against it.

Finally, Lexington repeatedly emphasizes Zurich’s

attempts to obtain collateral to secure the debtor’s ob-

ligations, arguing that the issue presented arises only

because some collateral failed. But the collateral is en-

tirely irrelevant to whether Zurich has a claim for de-

ductibles entitled to administrative priority. Initially,

Lexington’s focus on collateral begs the question pre-

sented: if, as Lexington contends, Zurich has no claim

in bankruptcy for the deductibles, but can proceed only

against the dissolved post-bankruptcy entity, collateral

from the debtor would not protect Zurich. Moreover,

contrary to Lexington’s suggestion, administrative

creditors routinely seek and obtain collateral, in part to

protect against administrative insolvency—the risk

that the estate will have insufficient assets even to pay

administrative claims. Indeed, most loans to debtors-

in-possession are secured by collateral. See 11 U.S.C.

§364(c) (contemplating that debtors-in-possession will

obtain secured loans). But it does not follow that such

lenders’ claims do not enjoy administrative priority. In

short, the existence of collateral has no bearing on the

important unresolved issues presented here—issues

that arise in a wide variety of bankruptcy cases and

merit this Court’s review.

CONCLUSION

The petition should be granted.

Respectfully submitted.