Andrews v. Riggs National Bank (In re Andrews)

OPINION

ELLIS, District Judge:

This appeal requires us to decide whether payments to a bankrupt debtor pursuant to a non-competition agreement constitute “earnings from services performed” under 11 U.S.C. § 541(a)(6). The bankruptcy court found that the non-competition agreement was ancillary to a pre-petition transaction, and thus payments under the agreement did not fall within § 541(a)(6). The district court agreed. Because we concur, we affirm.

*908I.

Appellant John A. Andrews (“Andrews”) worked in the ready-mix concrete business most of his life. In 1974, he and various partners formed a ready-mix concrete company in Herndon, Virginia. The company, which ultimately came to be known as AMAX Corporation (“AMAX”), grew to be quite successful, with annual sales of approximately thirty million dollars. As a part owner of AMAX, Andrews was personally active in the company and consequently developed numerous and substantial customer contacts and relationships in the concrete business. He expanded these contacts in 1980 by forming a real estate development company, which allowed him to participate in joint ventures with builders and developers.

In 1989, Andrews and the other owners of the company negotiated with Tarmac Acquisition, Inc. (“Tarmac”) for the latter to purchase the assets of AMAX and related entities. Both sides to the negotiations retained independent experts to value AMAX’s assets. The final sale price of nine million dollars was based on these expert valuations. Tarmac also purchased AMAX’s customer list, representing the good will of the company, for an additional one million dollars. At the same time, the principal owners of AMAX, including Andrews, entered into separate non-competition agreements with Tarmac. These agreements were an express condition of the asset sale because Tarmac was concerned about the AMAX principals’ substantial customer relationships and contacts in the ready-mix concrete business.

Andrews’s non-competition agreement with Tarmac (“NCA”), dated July 17, 1989, provided that he would not compete with Tarmac in the ready-mix concrete business in Northern Virginia, the District of Columbia, or the adjacent portions of Maryland for a period of four years. In exchange, Andrews was to receive one million dollars. Absent setoff,1 this one million dollars was to be paid in quarterly installments of $62,500, plus ten percent annual interest. Andrews asserts that the payments were structured in this manner to approximate his AMAX salary. Yet, he also concedes that Tarmac arrived at the one million dollar figure based on its estimate of the value of eliminating future competition from Andrews.

Andrews treated his NCA payments as ordinary income for federal tax proposes. This treatment was not to his advantage, as the top tax rate on ordinary income was thirty-one percent, significantly more than the twenty-eight percent rate that would have been applicable had he claimed the payments as capital gain from the sale of assets. See 26 U.S.C. § 2. In addition, by claiming the NCA payments as ordinary income, Andrews became subject to an additional self-employment tax of between ten and fifteen percent. See 26 U.S.C. §§ 1401-1402.

On October 14, 1992, Andrews filed a voluntary petition for relief under Chapter 7, 11 U.S.C. § 701 et seq., in the United States Bankruptcy Court for the Eastern District of Virginia. On December 4, 1992, Andrews instituted this contested proceeding against the estate trustee Richard G. Hall (“trustee”) pursuant to Rule 9014, Fed.R.Bankr.P. The motion initiating the proceeding sought to exclude from Andrews’s bankruptcy estate all post-petition payments due him under the NCA. The total of these payments is $250,-000 plus interest.2 According to Andrews, the payments represented his only source of income while the NCA remained in effect *909because the NCA precluded him from engaging in the ready-mix concrete business. But for the NCA Andrews asserts, he could have profitably re-entered the ready-mix concrete business.

The bankruptcy court denied Andrews’s motion, holding that compliance with a non-competition obligation closely connected with the pre-petition sale of an asset does not constitute “services performed” under 11 U.S.C. § 541(a)(6). The district court affirmed, and this appeal followed.

II.

The question presented is whether the payments due Andrews under the NCA qualify as “earnings from services performed” under 11 U.S.C. § 541(a)(6). If so, they are excluded from Andrews's bankruptcy estate, and he may use and enjoy them free from the claims of his creditors. If not, the payments become part of the estate and hence available to satisfy outstanding creditors’ claims.

Analysis properly begins with the language of the statute itself. See United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 241, 109 S.Ct. 1026, 1030, 103 L.Ed.2d 290 (1989). Section 541 of the Bankruptcy Code provides that the bankruptcy estate consists of certain broadly defined categories of property,3 but specifically excludes “earnings from services performed by an individual debtor after the commencement of the case.” 11 U.S.C. § 541(a)(1), (6). The phrase “services performed” is not defined in the statute. We are left, then, to construe the phrase in accordance with its ordinary meaning or, if that meaning be ambiguous, to give it the meaning most consistent with the statute’s purpose. Crandon v. United States, 494 U.S. 152, 158, 110 S.Ct. 997, 1001-02, 108 L.Ed.2d 132 (1990); see also Kolcoszka v. Belford, 417 U.S. 642, 645, 94 S.Ct. 2431, 2433, 41 L.Ed.2d 374 (1974) (stating • that “purposes of the Bankruptcy Act must ultimately govern” in determining scope and limitations of term “property” in 11 U.S.C. 110a(5)).

As the parties’ contentions reflect, the ordinary meaning of the phrase is infected with ambiguity. Thus, Andrews suggests that refraining from competition amounts to “performing services” because it confers a benefit on Tarmac. The trustee responds, more plausibly, that the phrase “services performed” is stretched out of shape if it is taken to include refraining from doing something, i.e., not competing, as contrasted with doing something or taking action. According to the trustee, performing a service implies doing an act, not refraining from doing an act. Although the contest of ordinary meanings tilts somewhat in favor of the trustee’s construction, ordinary meaning simply does not answer decisively whether the phrase encompasses refraining from competing pursuant to a noncompetition agreement. We must therefore ascertain the purpose of the statutory provision so we can assign to the phrase the meaning most consistent with that purpose. See Crandon, 494 U.S. at 158, 110 S.Ct. at 1001-02. This inquiry, of course, is informed by the purposes underlying federal bankruptcy law as a whole.

Section 541, like the Bankruptcy Code generally, has two overarching purposes: (1) providing protection for the creditors of the insolvent debtor 4 and (2) permitting the debtor to carry on and rebuild his life, that is, to make a “fresh start.”5 The first purpose is effectuated through statutory provisions that marshal and consolidate the debtor’s assets into a broadly defined estate6 *910from which, in an equitable and orderly process, the debtor’s unsatisfied obligations to creditors are paid to the extent possible.7 The second purpose finds expression in the bright line the Bankruptcy Code draws between pre- and post-bankruptcy filing events.8 Thus, § 541(a)(1) provides that the estate includes the debtor’s legal and equitable interests “as of the commencement of the case,” and leaves the bankrupt debtor free after that date to accumulate new wealth so that he might make a fresh start following bankruptcy. Similarly, the provision in issue here, § 541(a)(6), allows the debtor to exclude from his estate any compensation or salary he might earn after the date of the petition. Toward the same end, § 727 facilitates the fresh start by ultimately discharging the balance of the debtor’s unpaid obligations after the estate is exhausted. See 11 •U.S.C. § 727.

Sometimes the Bankruptcy Codes two proposes appear to conflict, as when a debtor claims property to aid his fresh start while his creditors claim the same property to satisfy the debtors obligations to them. Yet, this conflict is illusory, for by drawing the bright line between the debtor’s pre- and post-petition assets, the Bankruptcy Code harmonizes the two purposes. And it is this bright-line harmonizing principle that provides the decisive clue to construing § 541(a)(6) in this context. This clue points convincingly to the conclusion that payments pursuant to a pre-bankruptcy non-competition agreement are not “earnings from services performed.” Only this construction of § 541(a)(6) gives effect to the statutes purposeful distinction between a debtor’s pre- and post-petition assets. Pre-petition assets, like the NCA payments, are those assets rooted in the debtor’s pre-petition activities, including any proceeds that may flow from those assets in the future. These assets belong to the estate and ultimately to the creditors. Post-petition assets are those that result from the debtor’s postpetition activities and are his to keep free and clear of the bankruptcy proceeding.

The Supreme Court, in an analogous setting, acknowledged this bright line in Segal v. Rochelle, 382 U.S. 375, 86 S.Ct. 511, 15 L.Ed.2d 428 (1966). There, the question presented was whether loss-carryback tax refunds should be included in the debtors estate under § 70a(5) of the Bankruptcy Act, 11 U.S.C. § 110a(5).9 The refunds stemmed from losses incurred by the debtor prior to the bankruptcy filing. On these facts, the Supreme Court held that the refunds were properly included in the debtor’s estate because they were “sufficiently rooted in the pre-bankruptcy past and so little entangled with the bankrupts’ ability to make an unencumbered fresh start.” Segal, 382 U.S. at 380, 86 S.Ct. at 515.

Seen in this light, the NCA payments due Andrews fall clearly on the pre-bankruptcy or “past” side of the bright line. These payments are plainly rooted in, and grow out of, Andrews’s pre-petition activities. Thus, it is undisputed that the NCA was more than just contemporaneous with Tarmac’s purchase of the AMAX assets; it was an integral part of that purchase.10 This is precisely *911what the bankruptcy judge meant when he found that the NCA was “ancillary” to the sale of the business: but for the asset sale, there would have been no NCA and no quarterly payments to Andrews. Tarmac’s right to set off amounts owed it for breach of the purchase agreements from payments to Andrews under the NCA, as well as the express condition of sale that Andrews enter into such an agreement, further evidence the synergistic relationship between these contracts. Given this close connection between the NCA and the pre-petition sale of the debtor’s share in the concrete business, we are persuaded that the payments were well “rooted in the pre-bankruptcy past.” See Segal, 382 U.S. at 380, 86 S.Ct. at 515. We think they were also “so little entangled with the bankrupt’s ability to make a fresh start” that they should be included in Andrews’s estate. See id.11

In sum, § 541(a)(6)’s purpose, aided by its more plausible ordinary meaning, compels the conclusion that “earnings from services performed” should not be construed to include payments made under the NCA between Andrews and Tarmac. Were the rule otherwise, debtors would be able, indeed invited, to circumvent the bankruptcy laws through clever use of agreements not to compete. Specifically, a debtor selling a business, yet anticipating filing bankruptcy, could divert sale proceeds from the bankruptcy estate by shifting these proceeds from pre-petition sales payments to post-petition non-competition payments. There, as here, the post-petition noncompetition payments are not part of the debtor’s fresh start efforts, but rather payments that are rooted in the debtor’s pre-petition conduct. As such, these are payments that § 541(a)(6) contemplates should be included in the bankruptcy estate.

No other circuits appear to have confronted this precise question.12 Among lower courts that have done so, however, we find ample support for our conclusion.13 And the only cited contrary authority is inapposite or unpersuasive. First, Andrews urges that the decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir.1985), compels a different result from that reached here. That decision, however, is largely irrelevant to the instant ease. Lubrizol merely held that continuing duties of notice and forbearance could render a contract executory for the purposes of § 365, a bankruptcy provision that applies in a context different from that of § 541. See Lubrizol, 756 F.2d at 1045. From this, Andrews argues that the NCA is executory in nature and therefore that postpetition payments were made in exchange for post-petition forbearance. The argument is unconvincing. Even assuming the NCA may be *912characterized as an executory agreement,14 it does not thereby follow that the contract is one for the ‘performance of services15 within the meaning of § 541(a)(6). Furthermore, Congress, in enacting § 365, clearly indicated that rejected executory agreements fall on the prepetition side of the bright line by providing that the rejection will be deemed to have occurred just prior to the filing of the petition. See 11 U.S.C. 365(g); see also H.R.Rep. No. 595, 95th Cong., 1st Sess. 349 (1977) and S.Rep. No. 989, 95th Cong., 2d Sess. 60 (1978) (stating that purpose of § 365(g) “is to treat rejection claims as pre-petition claims”). In sum, the purposes underlying the Bankruptcy Code in general, and § 541 in particular, persuasively support the conclusion that the NCA payments are not excludable from the bankruptcy estate, even if the NCA is an executory agreement for purposes of § 365.

One district court has held that payments pursuant to a noncompetition agreement are not “property” within the meaning of § 541(a)(1). See In re Hammond, 35 B.R. 219 (Bankr.W.D.Okla.1983). The reasoning behind the Hammond court’s decision was apparently its conclusion that the debtor had “not done all acts necessary to accrue his right to the future payments.” Hammond, 35 B.R. at 223. The court went on to assert that, in order to receive the payments, “Hammond must abide by the agreement. We cannot force him to comply.” Id. This statement, however, is manifestly incorrect. Although the Thirteenth Amendment prohibits a court from specifically enforcing a personal service contract, an agreement not to compete is specifically enforceable if it is reasonable. See, e.g., Blue Ridge Anesthesia & Critical Care, Inc. v. Gidick, 239 Va. 369, 371, 389 S.E.2d 467 (1990). Thus, a bankruptcy court could issue a negative injunction prohibiting a person from engaging in activity violative of a non-competition agreement. The reasoning of Hammond is therefore fatally flawed. No “services” or acts were actually required before Hammond — or Andrews here — could acquire a right to payment under the agreement not to compete. In fact, all the debtor had to do to acquire that right was not perform any act that would constitute competition.

Accordingly, we hold that the payments due Andrews under the NCA do not fall within the definition of “earnings from services performed” under 11 U.S.C. § 541(6). These payments were thus properly included in his estate. The judgment of the district court is affirmed.16

AFFIRMED

. Andrews's payments under the NCA were subject to setoff by Tarmac if anyone involved with AMAX breached the main contracts for the asset sale, or if Tarmac acquired an indemnification claim against Andrews or the other AMAX principals. Setoffs against Andrews’s payments occurred. Specifically, the bankruptcy court found that Tarmac recovered some $400,000 from Andrews through the NCA's setoff mechanism in the years following the asset sale. Andrews agrees that Tarmac exercised its right of setoff against Andrews's NCA payment in the amount of $50,000 during the summer of 1992. He also asserts, however, that he repaid the other $350,-000 separately. The bankruptcy court’s finding in this regard is neither part of this appeal nor germane to it.

. When Andrews filed his Chapter VII petition, there were four payments remaining under the NCA. These payments, which were due in October 1992 and January, April, and July 1993, have been paid into Andrews's estate. The NCA expired on July 16, 1993.

. For example, the estate will include all of the debtor’s legal and equitable interests in property, § 541(a)(1), certain interests of the debtor and the debtor's spouse in community property, § 541(a)(2), and any interest in property the debtor acquires by way of inheritance or a divorce settlement within 180 days of the filing of the bankruptcy petition, § 541(a)(5).

. H.R.Rep. No. 595, 95th Cong., 1st Sess. 366-68 (1977); S.Rep. No. 95-989, 95th Cong., 2d Sess. 82-83 (1978) U.S.Code Cong.& Admin.News 1978, pp. 5787, 5868, 5869, 5963, 6321-6323.

. See Segal v. Rochelle, 382 U.S. 375, 379, 86 S.Ct. 511, 515, 15 L.Ed.2d 428 (1966).

. For instance, § 541(a)(1) provides in pertinent part that property of the estate includes "all legal or equitable interests of the debtor in property” as of the time the bankruptcy petition is filed. 11 U.S.C. § 541(a)(1). Section 541(a)(6) further states that the estate is to include any "proceeds, *910product, offspring, rents or profits of or from” the estate that accrue even after the estate has been created. 11 U.S.C. § 541(a)(6).

. Harman v. First American Bank of Maryland (In re Jeffrey Bigelow Design Group, Inc.), 956 F.2d 479, 487 (4th Cir.1992); see also H.R.Rep. No. 595, 95th Cong., 1st Sess., 177-78 (1977) U.S.Code Cong. & Admin.News 1977, pp. 6136, 6137.

. See Goggin v. Division of Labor Law Enforcement, 336 U.S. 118, 125-26, 69 S.Ct. 469, 473, 93 L.Ed. 543 (1949).

. Section 541 is the successor provision to § 70a(5), and the legislative history of the Bankruptcy Reform Act of 1978 indicates that the result of Segal remains valid under the current Bankruptcy Code. See H.R.Rep. No. 595, 95th Cong., 1st Sess. at 367-68 (1977); S.Rep. No. 989, 95th Cong., 2d Sess. 82-83 (1978).

.Andrews, seeking to avoid this conclusion, makes much of the fact that the two experts on whom Tarmac and the AMAX principals relied to value the sale reached a figure of nine million dollars, the ultimate sale price. Because this figure included one million dollars for good will (in the form of customer lists), Andrews argues that the NCA payments were not in fact payments for good will that should be considered part of the sale and thus part of his estate. This argument misses the point. Tarmac made the NCA a condition of the sale, and made the payments thereunder, to protect and maintain the good will it purchased from AMAX. See Unse*911cured Creditor's Committee v. Prince (In re Prince), 127 B.R. 187, 192 (N.D.Ill.1991) (holding that agreement not to compete provided in conjunction with sale of business is agreement not to undermine value of good will that has been sold); In re Mid-West Motors, Inc., 82 B.R. 439, 441 (Bankr.N.D.Tex.1988) ("Such [non-competition] provisions are necessary to secure the goodwill purchased by the buyer of the business."). Because of the nature and extent of Andrews’s experience in the ready-mix concrete business, AMAX's going concern value would likely have been worth little, if anything, absent the NCA.

.It is true that, at the time of the payments, Andrews could not have competed with Tarmac in the ready-mix concrete business in this area without breaching the NCA. Yet, the NCA expired in mid-1993, less than one year after Andrews filed his Chapter VII petition. He was free to re-enter the business after that time. Moreover, the NCA left Andrews free to pursue a fresh start in any area other than ready-mix concrete. Significantly, Andrews had previously been involved in the real estate development business. Although it is unclear whether he maintained this business after filing his bankruptcy petition, there is no evidence that he could not have done so in order to obtain funds for his fresh start.

. As the dissenting opinion correctly notes, the terse reference to this issue in Matter of Walden, 12 F.3d 445 (5th Cir.1994), is dictum.

. See, e.g., In re McDaniel, 141 B.R. 438, 440 (Bankr.N.D.Fla.1992) (finding payments to former employee in exchange for non-competition agreement not made for services performed and thus not excluded from estate under § 541(a)(6)); In re Prince, 127 B.R. at 192 (holding consideration for covenant not to compete contained in purchase agreement for sale of business not tantamount to "earnings from services perforated" post-petition); In re Bluman, 125 B.R. 359, 363 (Bankr.E.D.N.Y.1991) (same).

. Lubrizol involved a licensing agreement, not a non-competition covenant. See Lubrizol, 756 F.2d at 1045. Significant authority holds that an obligation to refrain from competition does not render a contract executory for the purposes of § 365. See, e.g., In re Hughes, 166 B.R. 103, 105 (Bankr.S.D.Ohio 1994); In re Paveglio, 1995 WL 465339 at *5 (Bankr.M.D.Pa.1993); In re Drake, 136 B.R. 325, 327-28 (Bankr.D.Mass.1992); In re Oseen, 133 B.R. 527, 529 (Bankr.D.Idaho 1991); In re Bluman, 125 B.R. at 362; In re Cutters, 104 B.R. 886, 890 (Bankr.M.D.Tenn. 1989). Notably, a number of these decisions came in jurisdictions that had adopted the same definition of executory contracts under § 365 that was adopted by this circuit in Lubrizol. See In re Paveglio, 1995 WL 465339 at *5; In re Oseen, 133 B.R. at 529; In re Bluman, 125 B.R. at 362; In re Cutters, 104 B.R. at 890.

. It is principally here that we part company from the dissenting opinion, which appears to assume that an executory contract is necessarily a contract for the performance of services that falls within § 541(a)(6). Yet, the assumption seems unwarranted, for it is at best ambiguous— even after Lubrizol — whether a continuing duty of forbearance, sufficient to render a contract executory, is equivalent to a continuing obligation to perform a service. Given the balance of policies reflected in § 541(a), the ambiguity is best resolved in favor of including in the debtor's estate income the debtor receives from his forbearance to compete.

.This holding does not, as the dissenting opinion claims, result in the trustee's assumption of the NCA. The trustee never assumed any duty to abstain from competing with Tarmac in the ready-mix concrete business. The only consequence of the holding here is that the remaining NCA payments are included in the debtor's estate, a result consistent with the statute's language and purpose.