Comm PA Dept Env Res v. Tri State Clinical ( 1999 )

Opinions of the United
1999 Decisions States Court of Appeals
for the Third Circuit
6-2-1999
Comm PA Dept Env Res v. Tri State Clinical
Precedential or Non-Precedential:
Docket 98-3332
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"Comm PA Dept Env Res v. Tri State Clinical" (1999). 1999 Decisions. Paper 147.
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Filed June 2, 1999
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 98-3332
COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF ENVIRONMENTAL RESOURCES,
Appellants,
v.
TRI-STATE CLINICAL LABORATORIES, INC.,
JOSEPH NIGRO, Trustee,
Appellees.
ON APPEAL FROM THE
UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
Civil Action No. 97-cv-02115
District Judge: Hon. Donald J. Lee
Argued: January 26, 1999
Before: SLOVITER, MCKEE, and RENDELL,
Circuit Judges.
(Filed June 2, 1999)
Stuart M. Bliwas, Esq. (Argued)
Pennsylvania Department of
Environmental Resources
Office of Chief Counsel
400 Market Street, P.O. Box 8464
Harrisburg, PA 17105
Attorney for Appellant
James M. Malley, Esq.
Joseph P. Nigro, Esq.
Matthew M. Pavlovich, Esq. (Argued)
Nigro & Malley
2 Gateway Center, Suite 1270
Pittsburgh, PA 15222
Attorneys for Appellees
Rachel J. Lehr, Esq.
Office of Attorney General of N.J.
25 Market Street
Trenton, N.J. 08625
Attorney for Amicus-Appellant
OPINION OF THE COURT
McKEE, Circuit Judge.
We are asked to decide if a criminal fine is entitled to
priority as an administrative expense under Chapter 7 of
the Bankruptcy Code. The fine was imposed upon a debtor
in possession for post-petition conduct that violated
Pennsylvania's Solid Waste Management Act.
Pennsylvania's Department of Environmental Resources
("DER") filed a proof of claim in which it asserted that it
was entitled to have the fine paid as an administrative
expense under S 503(b) of the Bankruptcy Code. The
bankruptcy court disagreed, and sustained the trustee's
objection to the proof of claim. The district court affirmed.
We hold that a post-petition criminal fine is not an
administrative expense under Chapter 7, and therefore we
affirm.
I. Factual Background and Procedural History
On August 14, 1990, Tri-State Clinical Laboratories, Inc.
filed a voluntary petition under Chapter 11 of the United
States Bankruptcy Code. A few months later, on October 4,
1990, two municipal workers were sprayed with blood while
emptying a dumpster located behind Tri-State's place of
business. The blood came from test tubes that Tri-State
2
had illegally placed in the dumpster. The test tubes would
have been collected and deposited in a municipal landfill
had they not been discovered.
On January 21, 1992, the Office of Attorney General filed
a criminal complaint charging Tri-State with violations of
Pennsylvania's Solid Waste Management Act for illegally
disposing of infectious waste. Count I of the complaint
charged Tri-State with unlawfully storing municipal waste
on or about July 18, 1990 (before Tri-State hadfiled its
Chapter 11 petition). Count II charged Tri-State with
unlawfully disposing of infectious waste in the dumpster on
or about October 4, 1990 (after Tri-State had filed its
Chapter 11 petition).
On September 10, 1992, Joseph P. Nigro was appointed
Chapter 11 Trustee. Shortly thereafter, on October 6, 1992,
the case was converted to Chapter 7, and Mr. Nigro was
appointed the Chapter 7 Trustee.
On July 28, 1994, while the Chapter 7 proceedings were
still pending, the Court of Common Pleas of Westmoreland
County convicted Tri-State on Counts I and II of the
complaint and imposed a fine of $10,000 for the violation
charged in Count I, and a fine of $20,000 for the violation
charged in Count II. It is undisputed that thesefines were
punitive in nature, and unrelated to actual costs or
expenses incurred by the DER.
On August 19, 1994, the DER filed a proof of claim
asserting a $10,000 subordinated unsecured claim under
11 U.S.C. S 726(a)(4); and a $20,000 claim for
administrative expenses pursuant to 11 U.S.C. SS 503(b),
507(a)(1), and 726(a)(1).1 The trustee objected to treating
the $20,000 fine as an administrative expense. However,
there was no objection to allowing the $10,000 claim for
pre-petition conduct under 11 U.S.C. S 726(a)(4), and that
fine is not an issue in this appeal.
The bankruptcy court concluded that administrative
expenses must be claimed by filing a "request for payment,"
and not by filing a "proof of claim." Accordingly, the
_________________________________________________________________
1. The bankruptcy court had previously granted the DER's motion to file
a proof of claim beyond the bar date.
3
bankruptcy court held that "[its previous] order granting
the DER leave to file its proof of claim beyond the bar date
is, in effect, a nullity." In the alternative, the court held that
the $20,000 fine for post-petition criminal conduct is not
an administrative expense under S 503(b). Instead, the
court allowed the DER to pursue the fine as an unsecured
claim.
The district court subsequently affirmed the bankruptcy
court's determination that the $20,000 fine was not an
administrative expense. Thus, it was not necessary for the
district court to decide if it agreed with the bankruptcy
court's conclusion that an administrative expense must be
asserted in a request for payment, rather than a proof of
claim. This appeal followed.2
II. Discussion
A.
The DER contends that the $20,000 fine imposed upon
the debtor in possession for conduct that occurred after it
filed the petition must be given priority status as an
_________________________________________________________________
2. The district court's appellate jurisdiction was based on 28 U.S.C.
S 158(a). We have jurisdiction pursuant to 28 U.S.C. S 158(c) and 28
U.S.C. S 1291. We exercise plenary review over a district Court's
bankruptcy decision. Universal Minerals, Inc. v. C.A. Hughes & Co., 669
F.2d 98, 100 (3d Cir. 1981). "Because the bankruptcy court, rather than
the district Court, was the trier of fact in this case, we are in as good
a
position as the district court to review the findings of the bankruptcy
court, so we review the bankruptcy court's findings by the standards the
district court should employ, to determine whether the district court
erred in its review." In re Fegeley, 118 F.3d 979, 982 (3d Cir. 1997)
(internal quotations omitted). Accordingly, we review the bankruptcy
court's findings of fact for clear error, and exercise plenary review over
legal issues. Id.
Although the parties have briefed the procedural issue of whether an
administrative expense can be asserted in a proof of claim, that issue is
not properly before us because it is not part of the district court's
order.
Moreover, because we conclude that the fines here are not administrative
expenses, we need not decide whether the administrative expense claim
was properly asserted.
4
administrative expense under S 503(b)(1)(A) of the
Bankruptcy Code. The DER bases its argument upon the
nonexclusive nature of the list of expenses in S 503(b), and
the fact that other courts have held that tort damages,
post-petition civil penalties, and civil environmental fines
are administrative expenses. The DER insists that there is
no rational basis to distinguish those civil penalties from
these criminal fines. According to the DER, both must be
treated as an "actual necessary expense of preserving the
estate" under S 503(b). Appellant's Br. at 10. The DER
seeks to bolster this argument with policy considerations. It
insists that if criminal fines are not given priority, "Chapter
11 debtors in possession [will be encouraged] to disregard
criminal statutes and other valid laws that might impede a
debtor in possession's effort to turn a profit," because such
a debtor can violate the law "secure in the knowledge that
no economic punishment would follow." Appellant's Br. at
23-24. The DER warns that this would "create[ ] an
incentive for any marginal corporate business to attempt to
free itself from regulatory restraints by seeking the safe
haven of Chapter 11 protection." Id. at 24.
The trustee's rejoinder relies heavily upon our decision in
Commonwealth of Pennsylvania Dept. of Environmental
Resources v. Conroy, 24 F.3d 568 (3d Cir. 1994). 3 The
trustee argues that we drew a distinction in Conroy
between compensatory assessments which may enjoy
priority status as actual administrative expenses, and non-
compensatory assessments which do not reimburse
creditors for actual expenses. The trustee argues that
because Congress expressly refers to non-compensatory
criminal fines and penalties elsewhere in the Code, it would
have expressly included such fines under S 503(b) if it
intended to treat them as administrative expenses. The
trustee also adds its own policy "spin" to rebut the policy
considerations that the DER urges upon us. The trustee
argues that non-compensatory criminal fines survive
bankruptcy, and can be assessed against the corporation or
_________________________________________________________________
3. Tri-State Clinical Laboratories and the trustee are jointly listed as
"appellee" on the briefs and in the caption. Inasmuch as we are deciding
the validity of the trustee's objection in the bankruptcy court we will
refer to the appellee as the "trustee."
5
corporate officers individually. Thus, those who are
responsible for the operation of the business have no
incentive to cut costs by violating the law as the DER
suggests. Appellee's Br. at 24-25.
B.
The starting point of any statutory analysis is the
language of the statute. Pennsylvania Dept. of Public
Welfare v. Davenport, 495 U.S. 552, 557-58 (1990); Kelly v.
Robinson, 479 U.S. 40, 43 (1986). Thus, we begin at the
beginning by examining the text of the statute. In doing so,
"we must not be guided by a single sentence or member of
a sentence, but look to the provisions of the whole law, and
to its object and policy." Kelly, 479 U.S. at 43 (internal
quotation marks omitted).
Section 503(b)(1)(A) of the Bankruptcy Code provides:
(b) [T]here shall be allowed, administrative expenses,
. . . including --
(1)(A) the actual, necessary costs and expenses of
preserving the estate, including wages, salaries, or
commissions for services rendered after the
commencement of the case . . .
11 U.S.C. S 503(b)(1)(A) (1997). Thus, for a claim to be given
priority as an administrative expense under this provision
of the Code, it must be (1) a "cost" or "expense" that is (2)
"actual" and "necessary" to (3) "preserving the estate."
We construe the words of a statute according to their
ordinary meaning, unless the context suggests otherwise.
See Moskal v. United States, 498 U.S. 103, 108 (1990);
Idahoan Fresh v. Advantage Produce, Inc., 157 F.3d 197,
202 (3d Cir. 1998). In Reading Co. v. Brown, the Supreme
Court concluded that "the words ``preserving the estate'
include the larger objective, common to arrangements, of
operating the debtor's business with a view to rehabilitating
it." 391 U.S. 471, 476-77 (1968). The dictionary defines
"necessary" as "absolutely required" or"needed to bring
about a certain effect or result." Webster's II New Riverside
University Dictionary 787 (1994). However, the Supreme
Court has held that the concept of "necessary costs" under
6
the Code is somewhat broader than would be suggested by
the dictionary definition. Thus, " ``usual and necessary
costs' should include costs ordinarily incident to operation
of a business, and not be limited to costs without which
rehabilitation would be impossible." Reading, 391 U.S. at
483.
To determine Congress' intent in enacting S 503(b)(1)(A),
we also must consider the other provisions of S 503. See
Neal v. Clark, 95 U.S. 704, 708-09 (1978) ("a word is known
by the company it keeps"). Section 503(b) specifically lists
several expenditures that are included within the meaning
of "administrative expenses." These include certain taxes
and fines or penalties that relate to those taxes, id. at
S 503(b)(1)(B) & (C); compensation for services rendered by
trustees and indenture trustees, id. at S 503(b)(2) &
S 503(b)(5); the actual, necessary expenses incurred by
certain creditors pressing their claims, id. at S 503(b)(3);
reasonable compensation for the professional services of
attorneys and accountants who provide particular services,
id. at S 503(b)(4); and other specified fees and mileage,
S 503(b)(6). These specified administrative expenses all
describe compensation for services that are necessarily
incident to the operation of a business, see, e.g.,
S 503(b)(2), (4) & (5), or reimbursement for actual expenses
incurred, see, e.g., S 503(b)(3) & (6).4 Moreover, paragraph
_________________________________________________________________
4. Although taxes incurred by the estate, as well as fines and penalties
relating to those taxes, are expressly included inS 503's definition of
administrative expense, taxes are treated uniquely throughout the
Bankruptcy Code, and the policies underlying the treatment of taxes do
not apply to other debts and expenses. Thus, the inclusion of taxes and
tax penalties in this section is not particularly helpful to our analysis.
Indeed, to the extent that the express reference to tax penalties in S 503
implies anything, it implies that Congress did not intend to include non-
compensatory criminal fines and penalties within the category of
"administrative expenses." Pursuant to well-established canons of
construction, the fact that Congress expressly included tax fines and
penalties in S 503 implies that had Congress intended to include other
types of fines and penalties within the class of administrative expenses,
it would have done so expressly. See Bates v. United States, 522 U.S. 23
(1997) (" ``[W]here Congress includes particular language in one section of
a statute but omits it in another section of the same Act, it is generally
presumed that Congress acts intentionally and purposely in the
disparate inclusion or exclusion.' ") (quoting Russello v. United States,
464 U.S. 16, 23 91983) (other internal quotation marks omitted)).
7
(1)(A) designates "wages, salaries, or commissions for
services rendered after the commencement of the case" as
"actual, necessary costs and expenses of preserving the
estate." See S 503(1)(A) (emphasis added). Thus, the
language of S 503(b), read as a whole, suggests a quid pro
quo pursuant to which the estate accrues a debt in
exchange for some consideration necessary to the operation
or rehabilitation of the estate. Priority, therefore, is afforded
such expenses to compensate the providers of necessary
goods, services or labor.
Such a construction is supported by the purposes of the
Bankruptcy Code. Chapter 11 is intended to "rehabilitat[e]
the debtor and avoid[ ] forfeiture by creditors." Pioneer
Investment Services, 507 U.S. at 389. The drafters of the
Code recognized that to achieve that purpose, the debtor
has to continue to operate between the filing of the petition
and the adjudication of bankruptcy. This can result in
additional expenses that are necessary to the continued
operation of the business or to successfully winding it
down. Congress recognized this need to provide an
incentive to creditors who otherwise would not continue to
provide services to a failing business. Accordingly,"the
actual, necessary costs and expenses of preserving the
estate" are given priority under the Code. See H.R. Rep. No.
95-595, at 186-187 (1977) reprinted in 1978 U.S.C.C.A.N.
5963, 6147 ("Those who must wind up the affairs of a
debtor's estate must be assured of payment, or else they
will not participate in the liquidation or distribution of the
estate."); id. at 187, 1978 U.S.C.C.A.N. at 6147-6148 ("The
purpose of [giving priority to wages earned within three
months before bankruptcy,] as with the administrative
expense priority, is in part to ensure that employees will
not abandon a failing business for fear of not being paid.");
Report of the Commission on the Bankruptcy Laws of the
United States, H.R. Doc. 93-137, pt. 1, at 214 (1973)
[hereinafter "Commission Report to the House"]
(recommending priority status for administrative expenses
incurred during the reorganization period because"[s]uch
expenses must be paid first to assure the availability of the
services needed to administer a liquidation or
reorganization case."). Absent the priority established under
S 503, a debtor in possession could not keep its employees,
8
nor obtain services necessary to its operation as it attempts
to reorganize, or wind-down pending ultimate liquidation.
We believe the relevance of this consideration extends to
interpreting Congress' intent in according priority to certain
claims under Chapter 7.
The Supreme Court's holding in Reading illustrates these
principles. In Reading, I. J. Knight Realty Corporation filed
a petition for an arrangement under Chapter 11 of the
Bankruptcy Act which was then in effect.5 The district court
appointed a receiver, and authorized him to continue to
conduct the debtor's business of leasing an industrial
building. Thereafter the building was totally destroyed by a
fire which spread to the surrounding property. In a
resulting tort action, one of the adjacent property owners
recovered a judgment against the receiver in an effort to
obtain compensation for the damage the fire inflicted upon
its property as a result of the receiver's negligence. Because
the debtor in possession was in bankruptcy, an issue arose
as to the priority that the judgment should be accorded
against the bankrupt estate. The Supreme Court held that
the tort judgment was entitled to priority as an
administrative expense under S 64a(1) of the Bankruptcy
Act, 11 U.S.C. S 104(a)(1), even though the expense was not
technically a cost of preserving the estate.6
The Court's holding was motivated by the considerations
of fairness and practicality which underlie the purposes of
the bankruptcy laws. The Court believed that those who
continue to transact business with the debtor during the
Chapter 11 case, and who suffer financially as a result, are
entitled to priority over other creditors who have not
affirmatively assumed such risk. The Court reasoned that
_________________________________________________________________
5. The prior Bankruptcy Act is analogous to the current version.
6. Section 64a of the prior Bankruptcy Act defined administrative
expenses in relevant part as follows:
The debts to have priority, in advance of the payment of dividends
to creditors and to be paid in full out of bankrupt estates, and
the
order of payment, shall be (1) the costs and expenses of
administration, including the actual and necessary costs and
expenses of preserving the estate subsequent tofiling the petition
. . . .
9
fairness dictates that those injured by the operation of a
bankrupt business by a receiver acting within the scope of
his authority be compensated for the injury. The Court
concluded that it simply is not fair to deny innocent victims
compensation for injuries they would not have incurred had
the law not allowed the debtor to continue operating its
business. Because Reading is so important to our inquiry
we take the liberty of quoting the Court's opinion at length.
The Court stated:
In our view the trustee has overlooked one important,
and here decisive, statutory objective: fairness to all
persons having claims against an insolvent. Petitioner
suffered grave financial injury from what is here agreed
to have been the negligence of the receiver and a
workman. It is conceded that, in principle, petitioner
has a right to recover for that injury from their
``employer,' the business under arrangement, upon the
rule of respondeat superior. Respondents contend,
however, that petitioner is in no different position from
anyone else injured by a person with scant assets: its
right to recover exists in theory but is not enforceable
in practice.
That, however, is not an adequate description of
petitioner's position. At the moment when an
arrangement is sought, the debtor is insolvent. Its
existing creditors hope that by partial or complete
postponement of their claims, they will through
successful rehabilitation, eventually recover from the
debtor either in full or in larger proportion than they
would in immediate bankruptcy. Hence the present
petitioner did not merely suffer injury at the hands of
an insolvent business: it had an insolvent business
thrust upon it by operation of law. That business will,
in any event, be unable to pay its fire debts in full. But
the question is whether the fire claimants should be
subordinated to, should share equally with, or collect
ahead of those creditors for whose benefit the
continued operation of the business (which
unfortunately led to the fire instead of the hoped-for
rehabilitation) was allowed. . . . The ``master,' liable for
the negligence of the ``servant' in this case was the
10
business operating under Chapter XI arrangement for
the benefit of creditors and with the hope of
rehabilitation. That benefit and that rehabilitation are
worthy objectives. But it would be inconsistent both
with the principle of respondeat superior and with the
rule of fairness in bankruptcy to seek these objectives
at the cost of excluding tort creditors of the
arrangement from its assets, or totally subordinating
the claims of those on whom the arrangement is
imposed to the claims of those for whose benefit it is
instituted.
* * *
In considering whether those injured by the
operation of the business during an arrangement
should share equally with, or recover ahead of, those
for whose benefit the business is carried on, the latter
seems more natural and just. Existing creditors are, to
be sure, in a dilemma not of their own making, but
there is no obvious reason why they should be allowed
to attempt to escape that dilemma at the risk of
imposing it on others equally innocent.
391 U.S. at 477-83.
The Court also considered the practical consequences of
not allowing the tort claimant to recover ahead of other
creditors.
More directly in point is the possibility of insurance. An
arrangement may provide for suitable coverage, and
the Court below recognized that the cost of insurance
against tort claims arising during an arrangement is an
administrative expense payable in full under S 64a(1)
. . . It is . . . obvious that proper insurance premiums
must be given priority, else insurance could not be
obtained; and if a receiver or debtor in possession is to
be encouraged to obtain insurance in adequate
amounts, the claims against which insurance is
obtained should be potentially payable in full.
Id. at 483.
Thirdly, the Court considered the background of tort law.
11
It has long been the rule of equity receiverships that
torts of the receivership create claims against the
receivership itself; in those cases the statutory
limitation to "actual and necessary costs" is not
involved, but the explicit recognition extended to tort
claims in those cases weighs heavily in favor of
considering them within the general category of costs
and expenses.
Id. at 485. The Court concluded that, because the torts of
a receivership create claims against the receiver, it could
not distinguish between claims arising from conduct which
is integral to the operation of the business, and torts
arising from "nonessential" activity.
No principle of tort law of which we are aware offers
guidance for distinguishing, within the class of torts
committed by receivers while acting in furtherance of
the business, between those "integral" to the business
and those that are not. . . . We hold that damages
resulting from the negligence of a receiver acting within
the scope of his authority as receiver give rise to
"actual and necessary costs" of a Chapter XI
arrangement.
Id. Inasmuch as the receiver was acting within the scope of
its authority, the demands of fair compensation required
that persons who were injured by the receiver's negligence
be compensated. This, in turn, required giving their claims
priority over the claims of other creditors.7
Here, allowing the DER's claim to be treated as an
administrative expense will allow that claim to be paid to
the exclusion of, and out of the resources otherwise
_________________________________________________________________
7. We realize that the debtor in Reading was seeking an arrangement
under Chapter 11, and the Court reached its holding in that context.
Here, of course, the defendant initially filed for the contemporary
counterpart of an arrangement -- a reorganization-- under Chapter 11,
and the case was thereafter converted to a liquidation ("straight
bankruptcy" using the terms of the prior Bankruptcy Act). However, we
think this is a distinction without a difference. In Reading the Court
noted: "It is agreed that this section [64a] applicable by its terms to
straight bankruptcies, governs payment of administration expenses of
Chapter XI arrangements". 391 U.S. at 475.
12
available for, claims of other creditors. The practical result
would be that fines for committing crimes would be paid by
innocent third persons -- the creditors -- rather than Tri-
State -- the criminal. That is as unfair as it is impractical.
The payment of the criminal fine would not compensate for
any damages resulting from Tri-State's conduct. It would
merely cause Tri-State to satisfy its obligations to the state
out of the pockets of Tri-State's creditors.
The DER argues that the cost of complying with the
criminal laws is a necessary cost of doing business (no less
than taxes, wages, or fees), and therefore any criminal
penalties in the form of fines resulting from violating the
law must be treated as an administrative expense. Thus,
the DER would have us hold that a violation of a criminal
law intended to protect public safety is necessary or
ordinarily incident to operating a business, and therefore, is
incurred as an expense of "preserving the estate." However,
the DER fails to recognize that, even if the costs associated
with operating a business in accordance with the law are
necessary to preserving the estate, it does not follow that
criminal fines and the conduct they attempt to punish are
ordinarily incident to operating a business. We refuse to
adopt an analysis of administrative expenses that is based
upon the assumption that legitimate businesses engage in
a "cost-benefit" analysis to determine if they will comply
with criminal laws that protect the very public that the
owners and operators of those legitimate businesses are
part of. It is neither reasonable nor necessary for a
commercial enterprise to violate criminal laws and
endanger the public to preserve the estate or to conduct
legitimate business operations, and we refuse the DER's
invitation to hold otherwise. Rather, we believe Congress
intended only for those "actual necessary costs and
expenses" that arise in the context of, or compensate for,
legitimate business activity, or the losses resulting
therefrom, to be treated as expenses of preserving the
estate, and accorded priority as an administrative expense.
Although both parties to this appeal rely upon our
holding in Conroy, supra, to support their arguments, we
view Conroy as supporting the distinction we draw between
claims for compensatory expenses and those for criminal
13
fines. In Conroy, the DER filed a claim for reimbursement
for costs incurred in cleaning up hazardous chemicals at a
site the Chapter 11 debtors had attempted to abandon. In
holding that those costs were administrative expenses
entitled to priority we said:
[I]f the DER had not itself undertaken to clean up the
[site,] the Conroys could not have escaped their
obligation to do so by abandoning the hazardous
property in question. Furthermore, if Frank Conroy
had arranged for cleanup of the facility after he had
filed a Chapter 11 petition, the costs of this cleanup
would have constituted administrative expenses under
11 U.S. C. S 503(b)(1)(A), since they are a portion of ``the
actual, necessary costs and expenses of preserving the
estate.'
Id. at 569. We also held that reimbursement for that
portion of the administrative and legal costs incurred in
arranging for cleanup which the DER had "sufficiently
substantiated" as reasonable compensation also qualified
as an administrative expense. Id. at 570-71. By cleaning up
the site, the DER provided a service to the debtor-- a
service that the debtor itself would have had to perform
during the course of normal operations -- and therefore,
the DER was entitled to compensation for that service.
The situation here is quite different. Tri-State was not
required to endanger the health and welfare of residents of
the community by illegally disposing of test tubes
containing blood, and the sanction that was imposed as
punishment for doing so has nothing to do with
compensation or proper business operations. Rather the
purpose of this criminal fine is deterrence, retribution, and
punishment.
C.
Our conclusion is also consistent with the legislative
history relating to the classification of non-compensatory
criminal fines and penalties. Before Congress replaced the
Bankruptcy Act of 1898 with the current Bankruptcy Code,
a creditor had to show that a claim was both "allowable"
(under S 57 of that Act), and "provable" (under S 63 of that
14
Act) before the creditor could participate in the distribution
of assets at all. See H.R. Doc. 93-137, pt. 1, at 21 (1973);
Kelly v. Robinson, 479 U.S. 36, 44-45 (1986). Section 57(j)
specifically excluded criminal penalties from the class of
allowable debts insofar as they did not compensate for an
actual loss. Section 57(j) of the Act provided:
Debts owing to the United States, a State, a county, a
district, or a municipality as a penalty or forfeiture
shall not be allowed, except for the amount of the
pecuniary loss sustained by the act, transaction, or
proceeding out of which the penalty or forfeiture arose.
30 Stat. 561 (emphasis added). Section 63 defined
"provable" debts to include criminal penalties. Thus, by the
early 1970s, when Congress began reexamining the
bankruptcy laws, it was well established that criminal fines
were not allowable debts subject to distribution from the
estate under Chapter 7.8
In 1973, the Commission on the Bankruptcy Laws of the
United States, which was established to propose changes to
the bankruptcy laws, recommended combining the concepts
of "allowable" and "provable" claims into a single enlarged
class of "allowable" claims. H.R. Doc. No. 93-137, pt.1, at
21. The Commission also recommended subordinating
certain claims to other unsecured claims within that large
class. Among this class of subordinated claims were claims
specified in S 4-406(a) of the proposed bill, including "any
claim, whether secured or unsecured, to the extent it is for
a fine, penalty or forfeiture or for multiple, punitive or
exemplary claims." Id. at 22 and pt. 2, at 115. The
Commission recommended changing the law to subordinate
such claims, rather than disallowing them, "to prevent the
debtor from obtaining a windfall of a disallowance intended
only to benefit its creditors." The Bankruptcy Reform Act:
Hearings on S. 235 and S. 236 Before the Subcomm. on
_________________________________________________________________
8. Tri-State's bankruptcy is an example of the frequency with which
cases begun under Chapter 11 eventually convert to Chapter 7. We do
not think that the conversion from Chapter 11 to Chapter 7 alters our
analysis. See Reading, supra (noting that the provisions for straight
bankruptcies govern priority under an arrangement under the prior
Code).
15
Improvements in Judicial Machinery of the Senate Comm. on
the Judiciary, 95th Cong. 761 (1975) [hereinafter "Hearings
S. 235"]. In that same Report, the Commission also
recommended establishing three categories of priority
claims: (1) administrative expenses, which the Commission
explained "must necessarily be given first priority in order
for estates to be liquidated and any distributions made to
any creditors"; (2) wages; and (3) taxes accruing within one
year prior to bankruptcy. H.R. Doc. 93-137, pt.1, at 21.
Based on the Commission's recommendations, the House
and the Senate drafted bills which provided for
subordinating and prioritizing certain kinds of claims. The
relevant provision, which was set forth in S 4-406 in both
bills, expressly subordinated any claim for a fine, penalty,
or multiple, punitive, or exemplary damages. See H.R.
10792, 93rd Cong. (1973); S. 236, 94th Cong. (1975). In
prepared remarks before the Senate subcommittee drafting
the proposed legislation, the Commission explained that
this subordination "is derived from sec. 57 of the present
Act which disallows fines, penalties, and forfeitures owing
the government. This provision simply subordinates. It
won't change the result in many cases but prevents any
return to a solvent debtor who has incurred a penalty and
extends the principle to exemplary and [sic] damages."
Hearings S. 235 at 15 (emphasis added).
In drafting the current Bankruptcy Code, Congress
considered the policy ramifications of subordinating
criminal penalties to unsecured debts. During
congressional hearings the Assistant Attorney General for
the Civil Division of the Department of Justice argued that
criminal judgments should not be subordinated, stating:
"Fine judgments represent a solemn judgment rendered
against a debtor for a crime against society. Thefine debtor
has not paid his debt to society until the fine is satisfied. As
a matter of public policy such judgments should at least
share priority with the Government's non-tax claims and
not be subordinated." Hearings S. 235 at 478. The
American Life Insurance Association argued to the contrary:
"[The Civil Division] overlooks the fact that in a bankruptcy
situation, the other creditors in effect end up paying the
fine if it is not subordinated. For that reason, it should not
16
be paid out of the estate unless all other claims
(subordinated or unsubordinated) are first paid in full."
Bankruptcy Act Revision: Hearings on H.R. 31 and H.R. 32
Before the Subcomm. on Civil and Constitutional Rights of
the House Comm. on the Judiciary, 94th Cong. 1590-91
(1976). Similarly, the Securities and Exchange Commission
recommended deleting S 4-406 entirely and substituting in
its place S 57(j) of the original Bankruptcy Act, which
disallowed fines and penalties. Hearings S. 235 at 736. The
SEC favored disallowance over subordination because it
feared that subordinated fines and penalties would still
take priority over the interests of stockholders. Id.
The statute as enacted did not include a separate section
covering subordinated claims. Instead, Congress enacted
S 726, "Distribution of property of the estate," which
"dictates the order in which [sic] distribution of property of
the estate, which has usually been reduced to money by
the trustee under the requirements of section 704(1)." S.
Rep. No. 95-989, at 96-97 (1978). Section 726 provides in
relevant part:
(a) . . . [P]roperty of the estate shall be distributed--
(1) first, in payment of claims of the kind specified
in, and in the order specified in, section 507 of this
title [referring to administrative expenses under
S 503];
(2) second, in payment of any allowed unsecured
claim . . . proof of which is [timely filed under
sections 501(a), (b), or (c), or tardily filed under
section 501(a)];
(3) third, in payment of any allowed unsecured claim
proof of which is tardily filed under section 501(a)
. . .;
(4) fourth, in payment of any allowed claim, whether
secured or unsecured, for any fine, penalty, or
forfeiture, or for multiple, exemplary, or punitive
damages, arising before the earlier of the order for
relief or the appointment of a trustee, to the extent
such fine, penalty, forfeiture, or damages are not
compensation for actual pecuniary loss suffered by
the holder of such claim;
17
(5) fifth, in payment of interest at the legal rate from
the date of the filing of the petition, on any claim
paid under paragraph (1), (2), (3), or (4) of this
subsection; and
(6) sixth, to the debtor.
11 U.S.C. S 726. The Senate explained paragraph (4) as
follows:
Fourth, distribution is to holders of fine, penalty,
forfeiture, or multiple, punitive, or exemplary damage
claims. More of these claims are disallowed entirely
under present law. They are simply subordinated here.
Paragraph (4) provides that punitive penalties,
including pre-petition tax penalties, are subordinated
to the payment of all other classes of claims, except
claims for interest accruing during the case. In effect,
these penalties are payable out of the estate's assets
only if and to the extent that a surplus of assets would
otherwise remain at the close of the case for distribution
back to the debtor.
S. Rep. No. 95-989 at 97 (emphasis added). Thus,
prepetition fines were accorded second class status in the
distribution scheme.
This provision works in tandem with S 523 of the current
version of the Code, which governs the dischargeability of
debts at the conclusion of the bankruptcy proceedings. To
understand S 523, however, it is useful to understand its
history as well. Section 17 of the old Bankruptcy Act
provided that a discharge in bankruptcy released a debtor
from all provable debts at the conclusion of the bankruptcy
case with four specified exceptions. Although criminal
penalties were not excepted from discharge underS 17,
courts historically had refused to discharge state criminal
penalties under federal bankruptcy because of
considerations of comity. See Kelly, 479 U.S. at 44-46. In
1978, Congress codified this judicial exception to
dischargeability of criminal fines and penalties in S 523.
That section, entitled "Exceptions to Discharge," provides:
(a) A discharge under section 727, 1141, 1228(a),
1228(b), or 1328(b) of this title does not discharge an
individual debtor from any debt --
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. . . (7) to the extent such debt is for a fine, penalty, or
forfeiture payable to and for the benefit of a
governmental unit, and is not compensation for actual
pecuniary loss, . . .
11 U.S.C. S 523(a)(7); see also FRBP Official Form 18
(9/97), Explanation of Bankruptcy Discharge in a Chapter
7 Case ("Some of the common types of debts which are not
discharged in a chapter 7 bankruptcy case are . . .[d]ebts
for most fines, penalties, forfeitures, or criminal restitution
obligations.").
The Supreme Court explained the evolution of this
exception to discharge in Kelly v. Robinson, 479 U.S. 40
(1986). In that case, a defendant was ordered to pay
restitution as a condition of probation after pleading guilty
to welfare fraud. After she was sentenced, she filed a
voluntary petition in bankruptcy under Chapter 7 listing
the restitution obligation as a debt. The appropriate state
agencies did not file a proof of claim in the court for the
outstanding restitution, but the bankruptcy court
nevertheless ruled that the restitution payments were not
dischargeable under S 523(a)(7) of the Code. The court held
that, even though restitution reimburses the victim of
criminal activity, its purpose is rehabilitation, and not
compensation. Thus, the criminal statute focused" ``upon
the offender and not the . . . the victim, . . . restitution is
part of the criminal penalty rather than compensation for a
victim's actual loss.' " Kelly, 479 U.S. at 41. The district
court agreed, but the Court of Appeals for the Second
Circuit reversed. It held that restitution was a"debt" as
that term was defined in the Bankruptcy Code. It relied
upon legislative history to conclude that "Congress intended
to broaden the definition of "debt" from the narrower
definition of the Bankruptcy Act of 1898." Id. The Court of
Appeals further concluded that the restitution was
discharged under S 523(a)(7), which provides for automatic
discharge of certain debts. The Supreme Court reversed,
relying in part on an opinion the New York Supreme Court
had reached four years before Congress enacted the current
Bankruptcy Code. The Supreme Court stated:
A discharge in bankruptcy has no effect whatsoever
upon a condition of restitution of a criminal sentence.
19
A bankruptcy proceeding is civil in nature and is
intended to relieve an honest and unfortunate debtor of
his debts and to permit him to begin his financial life
anew. A condition of restitution in a sentence of
probation is a part of the judgment of conviction. It
does not create a debt nor a debtor-creditor
relationship between the persons making and receiving
restitution. As with any other condition of a
probationary sentence, it is intended as a means to
insure the defendant will lead a law-abiding life
thereafter.
Thus, Congress enacted the Code in 1978 against the
background of an established judicial exception to
discharge for criminal sentences . . . an exception
created in the face of a statute drafted with
considerable care and specificity.
479 U.S. at 46 (internal quotation marks and citations
omitted).
Four years later the Supreme Court elaborated upon the
holding in Kelly, and emphasized the extent to which the
purpose of the Code was relevant to determining
dischargeability. In Pennsylvania Department of Public
Welfare v. Davenport, 495 U.S. 552 (1990), the Court held
that, even though restitution payments were not discharged
under Chapter 7, such payments were dischargeable
"debts" under Chapter 13. The Court explained:
[I]n locating Congress' policy choice regarding the
dischargeability of restitution orders in S 523(a)(7),
Kelly is faithful to the language and structure of the
Code: Congress defined "debt" broadly and took care to
except particular debts from discharge where policy
considerations so warranted. Accordingly, Congress
secured a broader discharge for debtors under Chapter
13 than Chapter 7 by extending to Chapter 13
proceedings some, but not all, of S 523(a)'s exceptions
to discharge. . . . Among those exceptions that
Congress chose not to extend to Chapter 13
proceedings is S 523(a)(7)'s exception for debts arising
from a "fine, penalty, or forfeiture." Thus, to construe
"debt" narrowly in this context would be to override the
20
balance Congress struck in crafting the appropriate
discharge exceptions for Chapter 7 and Chapter 13
debtors.
495 U.S. at 562-3.
We conclude that the policy considerations evidenced by
the aforementioned legislative history, as well as the text of
the Code and the cases interpreting it, support our view
that non-compensatory criminal fines imposed on a
Chapter 7 debtor or trustee should not be deemed
administrative expenses. This interpretation also is
consistent with Congress' limitation on the dischargeability
of criminal fines and penalties. Under Chapter 7, that
portion of a fine that is compensatory is discharged. 11
U.S.C. S 523(7). See Davenport, 495 U.S. at 559 ("The Court
in Kelly analyzed the purposes of restitution in construing
the qualifying clauses of S 523(a)(7), which explicitly tie the
application of that provision to the purpose of the
compensation required."). We do not believe that Congress
intended for us to ignore the non-compensatory character
of a criminal fine in deciding if it is an administrative
expense under S 503, while explicitly requiring that
consideration under S 523(7). Rather, for the reasons
previously stated, we conclude that S 503's restriction to
"expenses of preserving the estate" limits such expenses to
those that constitute compensation for expenditures
necessary to the operation of the debtor-in-possession's
business. As we noted above, we will not stretch our policy
analysis to include within this category the payment of the
criminal fines for Tri-State's conduct here.
We recognize, of course, that Tri-State may not have the
funds to pay this fine after the estate is liquidated.
However, that is often a possibility when criminalfines are
imposed, and we see nothing in the statutes that Tri-State
has violated, nor anything endemic to the process of
bankruptcy, that would justify us in removing the
Commonwealth's hand from the empty pockets of the
criminal, and placing it in the pockets of creditors merely
because those pockets are deeper. Tri-State was sentenced
while in bankruptcy for an act that occurred after it filed its
bankruptcy petition. The sentencing judge clearly knew
that Tri-State's ability to pay any fine was suspect at best.
21
Yet, the sanction here was on the corporate entity, not
upon the responsible individuals. It should not now come
as any great surprise that the bankrupt debtor lacks the
resources to pay this criminal fine and meet its obligations
to creditors. Tri-State's precarious financial condition does
not, however, allow us to stretch the concept of
administrative expense to remedy the DER's predicament.
D.
Finally, we realize, of course, that there is a certain
tension between our analysis here, and the analysis in N.P.
Mining Co. v. Alabama Surface Mining Commission, 963
F2d. 1449 (11th Cir. 1992). There, the court held that civil
fines imposed solely as punishment for violation of
environmental regulations were entitled to priority as an
administrative expense under Chapter 11. The holding was
based upon the requirement in S 969(b) that the trustee or
debtor in possession manage and operate the property in
compliance with state law. The court of appeals reasoned
that
[i]f postpetition costs "ordinarily incident to operation
of a business" that do not confer a benefit on the estate
[the tort claims in Reading] can indeed qualify as
"actual, necessary" expenses of preserving the estate,
then a strong case can be made that when a licensed
business operates in the regulated atmosphere of strip
mining in Alabama, incurring regulatory penalties is a
cost ordinarily incident to operation of a business and
should be accorded administrative-expense priority.
Id at 1454-5.
However, we do not think that rationale applies here,
even if it is appropriate for a civil fine on a business in a
heavily regulated industry. As noted above, doing so would
require us to infer that disposing of infectious human waste
in a manner that not only endangers members of the
general public, but also constitutes criminal activity, is part
of the ordinary and necessary operations of a business.
Moreover, the court in N.P. Mining stressed that the
violation before it did not involve safety. See N.P. Mining,
963 F.2d at 1458 ("Here, there is no threat to public health
22
or safety."). We are not convinced the court's holding would
be the same if it were faced with the kind of reckless
conduct in which Tri-State engaged. Finally, the court in
N.P. Mining did not consider the extensive legislative history
regarding prepetition penalties to be as relevant as we do in
determining whether punitive criminal fines should be given
preferential treatment. See id. at 1452 (stating "[t]he
legislative history of section 503(b) as well as the legislative
history of other relevant sections of the Bankruptcy Code,
is silent regarding the treatment of punitive post petition
penalties"). Accordingly, we are not persuaded by N.P.
Mining, the cases upon which it relies, or the cases that
have relied upon N.P. Mining. See, e.g. , In re Bill's Coal
Company, Inc., 124 B.R. 827 (D. Kan. 1991); In re
Charlesbank Laundry, Inc., 755 F.2d 200 (1st Cir. 1985); In
re Double B Distributors, Inc., 176 B.R. 271 (Bky. M.D.Fla.
1994); In re Motel Investments, Inc., 172 B.R. 105 (Bky.
M.D.Fla. 1994).
III. Conclusion
In sum, based on the plain language of the Bankruptcy
Code, its purpose and legislative history, and the principles
of fairness upon which the Code is grounded, we hold that
punitive criminal fines arising from post-petition behavior
are not administrative expenses under 11 U.S.C.S 503(b),
and therefore, are not accorded priority status pursuant to
S 507(a)(1). Therefore, the orders of the Bankruptcy Court
and the District Court will be affirmed in accordance with
this decision.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
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