Total Minatome Corp. v. Jack/Wade Drilling, Inc.

UNITED STATES COURT OF APPEALS

For the Fifth Circuit

___________________________

No. 00-30899
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IN THE MATTER OF JACK/WADE DRILLING, INC.,

Debtor.

TOTAL MINATOME CORP.,

Appellant,

VERSUS

JACK/WADE DRILLING, INC., PAUL N. DEBAILLON, TRUSTEE, UNITED STATES
TRUSTEE, and BAKER HUGHES, INC.,

Appellee.

Appeals from the United States District Court
for the Western District of Louisiana

July 13, 2001

Before EMILIO M. GARZA and PARKER, Circuit Judges, and ELLISON, District Judge.*

KEITH P. ELLISON, District Judge.

Appellant Total Minatome Corporation (“TMC”) appeals a district court judgment denying

its Motion for Payment of an Administrative Claim in the amount of $ 496,724.79 pursuant to Title

*
District Judge of the Southern District of Texas, sitting by designation.
11, Unit ed States Code, section 503(b)(1)(A). The question before us is whether a non-debtor

litigant is entitled to claim administrative priority for its attorney fees, costs, and expenses incurred

in post-pet ition litigation instituted by a bankruptcy trustee against the non-debtor, and awarded

pursuant to the pre-petition contract upon which the trustee based his litigation. Because we find that

the exception created in Reading Company v. Brown, 391 U.S. 471(1968) does not extend to this

award, we decline to grant administrative priority. The judgment of the district court is AFFIRMED.

I.

Appellant TMC and debtor Jack/Wade Drilling, Inc. entered into a turnkey drilling contract

on September 8, 1994. On April 27, 1995, Jack/Wade filed a Chapter 7 bankruptcy petition.

Appellee Paul N. DeBaillon, Jack/Wade’s trustee in bankruptcy, filed suit in federal district court on

June 17, 1996, for breach of that pre-petition drilling contract, alleging that TMC was obligated to

pay Jack/Wade for its drilling services and had failed to do so. TMC filed a counterclaim against the

trustee, alleging that Jack/Wade was the first to breach the contract by failing to drill to the proper

turnkey depth. Following a trial on the merits, a jury rejected both parties’ allegations of breach.

The contract provided for an award of attorney fees, costs, and expenses to the “prevailing

party” in any dispute on the contract and TMC sought that award. The district court, however, found

that, because the jury had rejected the allegations by both sides, neither party could be said to have

prevailed. TMC appealed to this Court, which vacated the district court’s order and remanded the

case for a determination of the “prevailing party.” On September 14, 1999, the district court

concluded that TMC was the “prevailing part y” and awarded $315,412.50 in attorney fees and

$181,312.29 in costs and expenses.

2
 On December 15, 1997, before resolution of the “prevailing party” dispute, TMC filed a

motion in bankruptcy court to have its claim for attorney fees, costs, and expenses given priority as

an administrative expense under 11 U.S.C. §503(b)(1)(A). A hearing on the motion was continued

to await resolution of TMC’s Fifth Circuit appeal of that dispute. The bankruptcy court heard TMC’s

request on November 9, 1999, and denied the motion to have its attorney fees, costs, and expenses

award treated as an administrative expense and given priority under the bankruptcy code.1 TMC

appealed the decision of the bankruptcy court to the district court, which affirmed the denial of its

motion. This appeal followed.

II.

We review the decision of the district court by applying the same standard to the bankruptcy

court’s findings of fact and conclusions of law as the district court applied. See In the Matter of

Pro-Snax Distributors, Inc., 157 F.3d 414, 419-20 (5th Cir. 1998). A bankruptcy court’s findings of

fact are subject to clearly erroneous review, while its conclusions of law are reviewed de novo. See

In re Gamble, 143 F.3d 223, 225 (5th Cir. 1998). Because this appeal presents only questions of pure

law, we review de novo.

Section 507(a)(1) of the bankruptcy code establishes that the administrative expenses incurred

in bankruptcy are to be given priority in distribution such that they are generally paid in full before

other unsecured non-prio rity claims. See 11 U.S.C. § 507(a)(1). These administrative expenses

1
Both the bankruptcy judge and the district court below found that TMC was not entitled to administrative
priority of its attorney fee claim on the alternative theory of assumption of an executory contract under 11 U.S.C. § 365.
On appeal, Appellant TMC neither presented this issue in oral argument nor urged it in its brief. We, therefore, find
the question to be not properly before the Court and we do not rule on it.

3
include the actual and necessary costs and expenses of preserving the estate. See 11 U.S.C. §

503(b)(1)(A). TMC asserts on appeal that its award of attorney fees, costs, and expenses constitutes

“actual and necessary costs” and should, accordingly, be given priority in the distribution of

Jack/Wade’s assets.

In order to qualify as an “actual and necessary cost” under section 503(b)(1)(A), a claim

against the estate must have arisen post-petition and as a result of actions taken by the trustee that

benefitted the estate. See Toma Steel Supply, Inc. v. Transamerican Natural Gas Corp. (In the

Matter of Transamerican Natural Gas Corp.), 978 F.2d 1409, 1416 (5th Cir. 1992) (finding that a

“prima facie case under § 503(b)(1) may be established by evidence that (1) the claim arises from a

transaction with the debtor-in-possession; and (2) the goods or services supplied enhanced the ability

of the debtor-in-possession's business to function”). Section 503(b)(1)(A) claims, therefore, generally

stem from voluntary transactions with third parties who lend goods or services necessary to the

successful reorganization of the debtor’s estate. See id. at 1415 (asserting that “[t]he purpose of

Section 503 is to permit the debtor’s business to operate for the benefit of its prepetition creditors”)

(citing In re Costal Carriers Corporation, 128 B.R. 400, 403 (D. Md. 1991)).

TMC admits that its claim against Jack/Wade does not meet the requirements for section

503(b)(1)(A) treatment because the debtor’s estate received no discernable benefit from the lawsuit

against TMC. See NL Industries, Inc. v. GHR Energy Corporation, 940 F.2d 957, 966 (5th Cir.

1991) (asserting that “[c]ourts have construed the words "actual" and "necessary" narrowly: the debt

must benefit [the] estate and its creditors”). TMC asserts, however, that its claim should be given

administrative priority under an except ion created by the Supreme Court for damages inflicted on

innocent third parties through a trustee’s operation of the debtor’s estate. See Reading Company v.

4
Brown, 391 U.S. 471, 485 (1968) (concluding 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” even when no actual benefit to the estate resulted).

The Supreme Court in Reading articulated a principle of “fairness to all persons having claims

against an insolvent” designed to guide courts in determining priorities in bankruptcy distributions.

See id. at 477. There is, of course and for good reason, a general presumption in bankruptcy favoring

equality in distribution such that “if one claimant is to be preferred over others, the purpose should

be clear from the statute.” See Nathanson v. NLRB, 344 U.S. 25, 29 (1952). When a third party is

damaged by the wro ngful conduct of a receiver in the course of operating the debtor’s estate,

however, the Court concluded that it would be unfair to force that party to share equally with those

creditors for whose benefit the estate was being operated. See Reading Company v. Brown, 391 U.S.

471, 478 (1968) (finding that the “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”).

The Reading exception has survived Congressional amendments to the bankruptcy code and

been recognized and applied by nearly every Court of Appeals in the nation. See, e.g., Yorke v.

NLRB, 709 F.2d 1138 (7th Cir. 1983) (applying Reading to damages incurred based on a trustee’s

failure to bargain with the union as required by federal law); In re Charlesbank Laundry, Inc., 755

F.2d 200 (1st Cir. 1985) (applying Reading to nuisance damages incurred based on the debtor’s

violation of a temporary injunction while operating its business); In the Matter of Al Copeland

Enterprises, Inc., 991 F.2d 233 (5th Cir. 1993) (applying Reading to taxes wrongfully withheld by

the debtor-in-possession and the interest earned on them). No Court of Appeals, however, has

extended Reading to cover debts incurred by a non-wrongful post-petition action to liquidate a

5
chapter 7 bankruptcy estate. 2 Because we do not find that Reading was intended to grant priority

to post-petition attorney fee awards resulting from a trustee’s good faith attempt to l iquidate the

debtor’s estate by bringing suit on a pre-petition contract, we decline Appellant’s invitation to be the

first to extend the exception.3

2
The bankruptcy appellate panel of the Ninth Circuit did, at one point, adopt an extremely broad
interpretation of Reading and grant administrative priority to an award of attorney fees based on a provision of a pre-
petition contract between the debtor and the third party. See In re Madden, 185 B.R. 815, 819 (B.A.P. 9th Cir. 1995)
(asserting that “a bankruptcy estate is answerable to claims for obligations it incurs, whether by contract or applicable
law”). While the decision in In re Madden led to similar opinions from district courts, it was later disavowed by the
Ninth Circuit in In re Abercrombie, 139 F.3d 755, 759 (9th Cir. 1998). See, e.g., In re Beyond Words Corporation,
193 B.R. 540, 546 (N.D. Cal. 1996) (relying on In re Madden to find that attorney fees granted under the prevailing
party provision of the pre-petition contract should be prioritized as an administrative expense because “a bankruptcy
estate should be answerable to claims for obligations it incurs, whether by contract or applicable law”). There, the
Court adopted the position of the First Circuit and held that the attorney fees awarded to a third party who successfully
fought a judgment the debtor-in-possession continued to defend would not be granted administrative expense priority
because the “source of the estate’s obligation remains the prepetition fee provision.” See In re Abercrombie, 139 F.3d
755, 759 (9th Cir. 1998) (citing In re Hemingway Transport, Inc., 954 F.2d 1 (1st Cir. 1992)).
In In re Kadjevich, 220 F.3d 1016 (9th Cir. 2000), the Ninth Circuit denied administrative priority to an
attorney fee award granted for a bad faith breach of a post-petition settlement of a pre-petition claim. The Court noted,
however, that “[w]e do not deal here with a case in which a representative of the estate commenced litigation on behalf
of the estate after a bankruptcy petition was filed.” Id. at 1021. This reservation, while relevant to the current analysis,
does not directly implicate the facts of the instant case because the statement appeared to focus on the pre-petition
genesis of the petitioner’s damage award. See id. at 1021. Further, the Court did overrule a district court decision
which allowed as an administrative expense the attorney fees awarded for bad faith opposition to a pre-petition
contempt suit. See id. at 1021 (citing disapprovingly In re Execuair, 125 B.R. 600 (C.D. Cal. 1991)).
A district court in In re Met-L-Wood Corporation, 115 B.R. 133 (N.D. Ill. 1990) also gave administrative
priority to a debt for attorney fees awarded to a party sued by the trustee. In that case, however, the trustee instituted
a lawsuit against the debtor’s attorney alleging he committed fraud during the liquidation of some of the debtor’s assets.
See id. at 134. Attorney fees were awarded by the bankruptcy court following a finding by the court that the trustee’s
lawsuit “proved to have [no] merit whatsoever.” See id. at 136. The court found the attorney fee award to be covered
by 11 U.S.C. § 330(a)(2) as an “actual [and] necessary expense[] of the debtor’s attorney” and gave it administrative
priority under that provision. See id. at 135. The Court did not address whether the fee award met the requirements
of section 503(b)(1)(A).

3
Appellee Paul Debaillon urges the Court to reject Appellant’s administrative expense claim against the
Jack/Wade estate as being a “pre-petition” debt because it arose out of a pre-petition contract. While we recognize that
many courts have defined post-petition damage awards that are traceable to pre-petition activity as “pre-petition” claims
automatically barred from administrative priority treatment, we decline to do so. See, e.g., In re Hemingway Transport,
Inc., 954 F.2d 1 (1st Cir. 1992) (denying administrative priority to an attorney fee claim arising out of post-petition
litigation on a pre-petition contract); In re Kadjevich, 220 F.3d 1016 (9th Cir. 2000) (denying administrative expense
priority to attorney fees awarded post-petition from post-petition litigation on a pre-petition claim).
Although TMC’s claim is traceable to a pre-petition transaction with the debtor – and would not exist but for
that pre-petition transaction – we prefer to avoid imposing the fictional label of “pre-petition” on a claim that is, in
reality, a post-petition claim. Neither TMC’s damages nor its right to recover on those damages arose until after the
trustee brought and lost its suit on the pre-petition contract. While we certainly consider TMC’s pre-petition dealings

6
 III.

In evaluating TMC’s bid for administrative priority of its attorney fees, the Court begins with

the presumption that all Jack/Wade’s creditors are equally innocent victims in this bankruptcy. See

Reading Company v. Brown, 391 U.S. 471, 482-83 (1968) (acknowledging that “[e]xisting creditors

are, to be sure, in a dilemma not of their own making”). The question before us, therefore, is not

whether TMC deserves to get paid, but whether TMC deserves to get paid at the expense of

Jack/Wade’s existing unsecured creditors.

The principle announced in Reading of “fairness to all persons having claims against an

insolvent” has survived Congressional amendments to the bankruptcy code. See Reading Company

v. Brown, 391 U.S. 471, 477 (1968); In the Matter of Al Copeland Enterprises, 991 F.2d 233, 239

(5th Cir. 1993) (noting that “[t]he Court’s opinion in Reading survived Congress’s revisions to the

Bankruptcy Code”). Consistent with this objective, the statute has identified certain creditors to be

preferred over others, and imposed a rule of equal distribution of the estate between the remaining

unsecured parties. See Nathanson v. NLRB, 344 U.S. 25, 29 (1952) (holding that “if one claimant

is to be preferred over others, the purpose should be clear from the statute”). The Reading exception

arose out of a particular set of facts in which the Supreme Court determined that this statutory

objective of fundamental fairness would be defeated if the statute were applied literally. See Reading

Company v. Brown, 391 U.S. 471, 477 (1968).

In Reading, the claimant was an owner of a neighboring business whose property was

damaged by a fire negligently caused by the bankruptcy receiver in the course of operating the

with the debtor to be relevant, we consider them a factor in determining whether Reading apples to grant administrative
priority to the disputed claim, rather than as a determination by itself.

7
debtor’s estate during a bankruptcy reorganization. See id. at 473-74. The Supreme Court held that

it would be unfair to force the fire victim to share equally with the existing creditors and granted

administrative priority to that claimant. See Reading Company v. Brown, 391 U.S. 471, 478 (1968)

(framing the question as “whether the fire claimants should be subordinated to, should share equally

with, or should collect ahead of those creditors for whose benefit the continued operation of the

business . . . was allowed”).

The Reading Court identified two factors that distinguished the claim of the fire victim from

that of a typical unsecured party who is injured post-petition; 1) the wrongful nature of the receiver’s

act, and 2) that the act was committed in the course of operating the debtor’s business so as to

improve the position of the existing creditors. See id. at 477-79. The Court determined that the

claimant was not merely an unlucky victim of the debtor’s bankruptcy, but a foreseeable casualty of

the receiver’s negligence in operating a business that would not otherwise be able to operate but for

the provisions of the bankruptcy statute. See id. at 478 (asserting that “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”). Because the receiver had chosen to operate the estate to improve the position

of the existing creditors, fairness dictated that the injured claimant be entitled to recover its damages

at the expense of the existing creditors when the receiver operated negligently.

Unlike the situation in Reading, fairness does not dictate that TMC’s claim for attorney fees

be paid at the expense of Jack/Wade’s existing creditors. The trustee acted neither wrongfully nor

in the course of operating the business of the debtor so as to attempt to improve the position of the

general creditors. He intended only to liquidate an existing claim on which he believed in good faith

the Jack/Wade estate was entitled to recover. The only difference between TMC and the existing

8
creditors of Jack/Wade is that TMC’s debt was incurred after Jack/Wade filed for bankruptcy. If

Jack/Wade had sued TMC and lost one day before filing for bankruptcy, TMC would be an unsecured

creditor with no claim to any priority of payment for its award of attorney fees. See In the Matter

of Al Copeland Enterprises, 991 F.2d 233, 240 (5th Cir. 1993) (granting administrative expense

priority under Reading and 503(b)(1)(A) to only the portion of the debt which accrued post-petition).

The Court does not find that this fortuity of timing, standing alone, creates a principled basis on which

to make an exception to the rule of equal distribution among creditors.4

4
We do not hold that a claimant must necessarily show a wrongful act committed in the course of a trustee’s
operation of a business in an attempt to improve the position of the existing creditors in order to obtain administrative
expense priority under the Reading exception. We simply hold that, in this case, fairness does not compel the granting
of administrative priority to TMC’s claim for attorney fees. The driving force behind the Supreme Court’s decision
in Reading was the great injustice that would result to the claimant if it were denied its right to recover its fire
damages; the real result of forcing it to collect a pro rata share of the estate with the existing creditors. Such
compelling facts are not present in the instant case.
In Reading, the claimant’s damages stemmed from a wrongful and unilateral act of the receiver and the
claimant had no reason to anticipate either the bankruptcy or the negligence of the receiver. See Reading Company
v. Brown, 391 U.S. 471, 477 (1968) (noting that “[p]etitioner suffered grave financial injury from what is here agreed
to have been the negligence of the receiver and a workman”). TMC’s damages, however, did not stem from any act
by the trustee that could be considered either as wrongful or as unilateral as that which the Court considered in
Reading. TMC chose to deal with Jack/Wade prior to the bankruptcy and voluntarily entered into the contract on
which the trustee based his lawsuit. We admit that TMC was likely unaware that Jack/Wade would be unable to meet
its financial obligations. Contracting parties, however, are expected to understand the risks associated with making
agreements with others. The degree of “innocence” which contributed to the extreme injustice that would have resulted
in Reading does not seem to be present in the present case. See id. at 483 (noting that existing creditors should not
“be allowed to attempt to escape [their] dilemma at the risk of imposing it on others equally innocent”). See also In
re Hemingway Transport, Inc., 954 F.2d 1, 7 (1st Cir. 1992) (asserting that “[a] chapter 7 trustee’s lawsuit may indeed
impose burdensome litigation expense upon successful and unsuccessful defendants alike, yet its prepetition genesis
ultimately distinguishes it from the postpetition losses accorded priority in Reading”) (emphasis in original).
We also note that the claimant in Reading suffered a real and generally compensable injury: actual damages
from the tortious conduct of the receiver. See id. at 473-74. TMC, on the other hand, seeks redress from attorney fees
it incurred in defending a lawsuit brought in good faith by the trustee. The general rule in American lawsuits is that,
absent a finding of bad faith, each party bear its own costs and expenses. See Vaughan v. Atkinson, 369 U.S. 527
(1962) (holding that the existence of bad faith can except a lawsuit from the “American rule” that each party is to bear
its own costs in litigation). The only reason that TMC is able to claim its attorney fees as damages is because of the
contractual provision. We cannot equate the injustice that would have resulted to the fire damage victim in Reading
had it been denied full recovery of its damages with that resulting to TMC in being denied full recovery of its
contractual attorney fees and costs.

9
 The Court recognizes that the trustee in the instant case, made a decision to act in manner

that would cause a third party to incur expense.5 Unlike the actions of the Reading receiver,

however, the actions of the trustee were taken in the course of responsibly carrying out the duties of

his position. In a chapter 7 bankruptcy, the trustee is expected to identify and liquidate all existing

claims on which the trustee has a good faith belief the estate is entitled to recover. See Watkins v.

Sedberry, 261 U.S. 571, 576 (1923) (noting that”[i]t was the duty of the trustee to employ counsel

to bring suit to recover the property belonging to the bankrupt”). To penalize the estate when the

trustee faithfully carries out these duties seriously undermines the incentive structure established by

the bankruptcy code.6

We recognize that we have strictly construed the Reading except ion. The limits we have

placed on its application are not, however, without support in neighboring circuits.7 Further, our

5
The trustee sued TMC knowing that TMC would incur financial injury through its payment of attorney fees
in defending the lawsuit . Further, the trustee knew that, in reality, the prevailing party provision of the contract he
sued upon would have force only if TMC lost the lawsuit because Jack/Wade was already insolvent. We admit that
this reality places Jack/Wade at an unfair advantage with relation to TMC, but all of Jack/Wade’s creditors are
disadvantaged in that manner; that is the nature of bankruptcy. Because this imbalance exists between TMC and
Jack/Wade – not between TMC and the existing creditors of Jack/Wade, – prioritizing TMC’s claim ahead of those
existing creditors does not remedy the unfairness of that situation.
6
We note that no similar penalty to unsecured creditors normally results from a trustee’s good faith
prosecution of a claim. The Court is concerned, therefore, with the possibility that, by prioritizing TMC’s attorney fee
award in this case, we would effectively be creating a way for parties to contract around the provisions of the
bankruptcy code.
7
The First Circuit in In re Hemingway Transport, Inc., 954 F.2d 1 (1st Cir. 1992) rejected a claim for
administrative expense priority on a set of facts nearly identical to those presented in the instant lawsuit. There, the
bankruptcy trustee sued a third party based on a pre-petition lease agreement which contained a prevailing party
attorney fee clause. See id. at 4. The third party successfully defended the suit and petitioned the bankruptcy court
to grant administrative expense priority to its attorney fee award under the principles of Reading. See id. The First
Circuit, in denying administrative priority, noted that the “postpetition operation of the [debtor’s] business under
chapter 11 in no manner caused or contributed to the attorney fees incurred . . . in resisting the chapter 7 trustee’s third
party action.” Id. at 6 (emphasis in original). While the court declined to establish a rule barring the application of
Reading in any chapter 7 liquidation proceeding, it did note that the award’s “prepetition genesis ultimately
distinguishes it from the postpetition losses accorded priority in Reading.” Id. at 7 (emphasis in original).

10
holding today is fully consistent with prior Fifth Circuit applications of Reading.8 For the foregoing

reasons, we affirm the judgment of the district court denying administrative priority treatment of

TMC’s attorney fee award.

Affirmed

8
The Reading exception to the normal section 503(b)(1)(A) rule of administrative priority has been applied
in only two cases in the Fifth Circuit. Both those cases, however, involved a wrongful act by the trustee or debtor-in-
possession committed in the course of a chapter 11 reorganization. In In the Matter of Al Copeland Enterprises, 991
F.2d 233 (5th Cir. 1993), this Court granted administrative expense priority to an award of interest on sales taxes
wrongfully withheld by the trustee of chapter 11 bankruptcy estate. In In the Matter of H.L.S. Energy Co., Inc., 151
F.3d 434 (5th Cir. 1998), this Court did not rely on Reading because we found that the state’s actions to plug wells that
the trustee had an obligation to plug “benefitted” the estate for purposes of granting section 503(b)(1)(A) administrative
expense priority to the state’s costs. We cited Reading, however, because the trustee, in its operation of the debtor’s
estate under chapter 11, violated the law and the state was damaged in course of attempting to remedy that violation.
See id. at 436.

11