Bachman v. Commercial Financial Services, Inc.

F I L E D
United States Court of Appeals
Tenth Circuit
PUBLISH
APR 24 2001
UNITED STATES COURT OF APPEALS
PATRICK FISHER
Clerk
TENTH CIRCUIT

In re: COMMERCIAL FINANCIAL
SERVICES, INC.,

Debtor.

JOHN BACHMAN; BRUCE PHELPS,

Appellants,

v. No. 00-5108

COMMERCIAL FINANCIAL
SERVICES, INC.,

Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF OKLAHOMA
(D.C. No. 99-CV-390-H)

Submitted on the briefs:

Greggory T. Colpitts of Magee & Colpitts, Tulsa, Oklahoma, for Appellants.

Larry M. Wolfson and Jerry L. Switzer, Jr. of Jenner & Block, Chicago, Illinois,
and Neal Tomlins and Ronald E. Goins of Tomlins & Goins, Tulsa, Oklahoma, for
Appellee.

Before HENRY , BRISCOE , and MURPHY , Circuit Judges.
MURPHY , Circuit Judge.

This case requires us to determine whether lump sum cash payments due

upon termination and promised to appellants when they executed employment

contracts with Commercial Financial Services, Inc., (CFS), were entitled to

priority as administrative expenses in CFS’s eventual bankruptcy. After

reviewing the briefs of the parties, the relevant case law, and the opinions of the

bankruptcy court and the district court, we affirm. 1

Appellants Bachman and Phelps entered into employment contracts with

CFS in which both employees were promised lump sum cash payments upon

termination by CFS prior to the expiration of the contracts unless such

termination was for cause. The lump sum payments equaled appellants’ annual

base salaries of $120,000 and $150,000, respectively. Before appellants’

contracts expired, CFS filed a voluntary petition for relief under Chapter 11 of the

Bankruptcy Code and assumed the role of debtor in possession. Appellants

continued to work for the debtor in possession, but each was terminated, without

1
After examining the briefs and appellate record, this panel has determined
unanimously that oral argument would not materially assist the determination of
this appeal. See Fed. R. App. P. 34(a)(2); 10th Cir. R. 34.1(G). The case is
therefore ordered submitted without oral argument.

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cause, within a month after the filing. Both appellants were paid full salaries for

the post-petition period in which they worked.

After the terminations and with the approval of the bankruptcy court

pursuant to 11 U.S.C. § 365(a), the debtor in possession rejected appellants’

employment contracts. Appellants then filed a motion in the bankruptcy court

seeking an order classifying their lump sum payments as priority administrative

claims under 11 U.S.C. § 503(b)(1)(A).

11 U.S.C. § 503(b)(1)(A) provides:

(b) After notice and a hearing, there shall be allowed administrative
expenses . . . including--

(1)(a)the actual, necessary costs and expenses of
preserving the estate including wages, salaries, or
commissions for services rendered after the
commencement of the case.

Administrative expenses allowed under § 503(b) are entitled to priority

pursuant to 11 U.S.C. § 507(a)(1) and § 726(a)(1). The policy behind such

priority is to encourage creditors to extend credit and supply debtors with goods

and services post-petition in order to increase the likelihood that a successful

reorganization will occur. See In re Jartran, Inc. , 732 F.2d 584, 587-88 (7th Cir.

1984). Creditors are unlikely to do this unless they are promised priority. Such

priority does no injustice to pre-petition creditors, because they will presumably

benefit more from a reorganized debtor than from one forced into liquidation. Id.

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at 586. Such priorities are strictly construed, however, “[b]ecause the

presumption in bankruptcy cases is that the debtor’s limited resources will be

equally distributed among his creditors.” Isaac v. Temex Energy, Inc. (In re

Amarex, Inc. ), 853 F.2d 1526, 1530 (10th Cir. 1988) (quotation omitted).

Administrative priority must have a clear statutory purpose; appellants can prevail

only by demonstrating that their claims “comport with the language and

underlying purposes of § 503.” Jartran, Inc. , 732 F.2d at 586.

In a thorough and well-reasoned opinion, the bankruptcy court held that the

lump sum payments were not “necessary costs and expenses of preserving the

estate” under 11 U.S.C. § 503(b)(1)(A) nor could they be compensation for

appellants’ post-petition services. Applying the First Circuit test articulated in

Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.) , 536 F.2d 950, 954

(1st Cir. 1976), and endorsed by this circuit in Amarex , 853 F.2d at 1530, the

bankruptcy court further determined that appellants’ claims neither arose from a

transaction with the debtor in possession nor benefitted the debtor in possession.

The bankruptcy court held that the claims, therefore, were not entitled to priority

as administrative expenses. The district court affirmed, and appellants appeal.

This court considered a situation similar to the present one in Amarex.

There, the claimant was party to an employment contract with Amarex providing

for a one-year $10,000 bonus which could be annualized over the first year.

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During the claimant’s first year of employment, Amarex was placed in

involuntary bankruptcy. After working for the debtor in possession for more than

a year after the filing, the claimant sought classification of the unpaid bonus as an

administrative expense.

In rejecting the district court’s conclusion that the entire bonus was entitled

to priority because it was earned post-petition, this court adopted the analysis of

the First Circuit in Mammoth Mart , 536 F.2d 950.

[A]n expense is administrative only if it arises out of a
transaction between the creditor and the bankrupt’s trustee or debtor
in possession (citations omitted) and only to the extent that the
consideration supporting the claimant’s right to payment was both
supplied to and beneficial to the debtor-in-possession in the
operation of the business. A debt is not entitled to priority simply
because the right to payment arises after the debtor in possession has
begun managing the estate.

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Amarex , 853 F.2d at 1530 (quotations omitted). 2
Largely because the bonus at

issue in Amarex was “guaranteed” and “annualized” and because the claimant

could draw a monthly advance against it, we agreed with the bankruptcy court that

the bonus was part of the claimant’s “agreed salary, and was earned day by day

during that first year.” Id. at 1531. Priority was accorded only that portion of the

bonus earned post-petition because “[o]nly those services were ‘consideration

supporting the claimant’s [Isaac’s] right to payment . . . both supplied to and

beneficial to the debtor-in-possession in the operation of the business.’” Id. at

1532 (quoting Mammoth Mart , 536 F.2d at 954). Amarex is not limited to cases

involving employee bonuses and sets out this circuit’s definitive procedure for

determining all administrative expense claims, including the severance-pay-type

claims presented here. General Am. Transp. Corp. v. Martin (In re Mid Region

Petroleum, Inc.) , 1 F.3d 1130, 1133 n.5 (10th Cir. 1993).

2
Appellants in the bankruptcy court relied on language in Amarex which
quoted Trustees of Amalgamated Insurance Fund v. McFarlin’s, Inc. , 789 F.2d 98
(2d Cir. 1986), to argue that, because severance pay is compensation for the
hardship employees face when they are terminated, severance pay is earned upon
dismissal. Amarex , 853 F.2d at 1530-31. That statement in McFarlin’s was
meant to summarize Second Circuit case law on the issue of severance pay. The
reference to that statement, as dicta, in Amarex was part of this court’s effort to
illustrate the disagreement among the circuits regarding the treatment of
severance pay as an administrative expense. The ultimate decision in Amarex
resulted from the application of Mammoth Mart , a case rejecting the Second
Circuit approach to severance pay claims in bankruptcy. Appellants’ suggestion
that this circuit finds all severance pay claims entitled to administrative priority
rests on a misreading of Amarex.

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 Applying the Amarex/Mammoth Mart test to the facts of this case, we agree

with the bankruptcy court and the district court that these claims for lump sum

termination payments should not be accorded priority as administrative expenses.

In order to attain such status, the claims must have arisen from a transaction with

the debtor in possession. Amarex , 853 F.2d at 1530. Appellant’s argue that they

had a transactional relationship with the debtor in possession because the debtor

in possession continued to employ them post-petition and paid them for their

work. This is insufficient to establish a transaction with the debtor in possession

for administrative priority purposes.

“It is only when the debtor-in-possession’s actions themselves -- that is,

considered apart from any obligation of the debtor -- give rise to a legal liability

that the claimant is entitled to the priority of a cost and expense of

administration.” Mammoth Mart , 536 F.2d at 955. It is crucial that the

claimant’s performance be induced by the debtor in possession. Jartran, Inc. , 732

F.2d at 587.

Here, there is no evidence that the debtor in possession assumed the

employment contracts or entered into new post-petition contracts with appellants.

In fact, shortly after the terminations, the debtor in possession rejected the

employment contracts. The debtor in possession did nothing to give rise to legal

liability for payment of the lump sum amounts. Nor did the debtor in possession

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induce appellants’ performance by promising to pay them the lump sum amounts

if they would continue to work post-petition.

Further, it is not determinative that payment of the lump sum was

contingent upon appellants’ termination, an event which occurred post-petition.

In determining administrative priority, courts look to “when the acts giving rise to

a liability took place, not when they accrued.” Pension Benefit Guar. Corp. v.

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

1997); see also Pension Benefit Guar. Corp. v. Skeen (In re Bayly Corp.) , 163

F.3d 1205, 1208-09 (10th Cir. 1998). Here, in order for appellants to prevail, the

liability must arise post-petition; it is not enough that the right to payment arose

after the debtor in possession assumed control. Amarex , 853 F.2d at 1530. The

liability arose at the time the contracts were executed; only the right to payment

arose upon appellants’ termination. Appellants have not shown that their claims

arose from a transaction with the debtor in possession and thus have not met the

first prong of the Amarex/Mammoth Mart test.

The second requirement for administrative priority is that “the

consideration supporting the claimant’s right to payment was both supplied to and

beneficial to the debtor-in-possession in the operation of the business.” Id.

(quotation omitted). Appellants’ claims also fail on this front.

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 Appellants argue that they satisfy this requirement because, by working for

the debtor in possession for some three weeks after the filing, they provided

services which benefitted the estate. This showing, however, is insufficient to

establish that the consideration supporting the right to payment of the lump sum

“was both supplied to and beneficial to the debtor-in-possession in the operation

of the business.” Id. (quotation omitted).

With regard to the requirement that the consideration must be supplied to

the debtor in possession, there is nothing in the record to suggest that appellants’

work for the debtor in possession for three weeks post-petition was consideration

for the large lump sum payments at issue here. Indeed, the consideration for the

lump sums was the agreement by appellants, supplied pre-petition, that they

would forego other employment opportunities and sign on with CFS as

employees. That consideration included obligating themselves to work for CFS

for two years and to move their residences from other states to Tulsa, Oklahoma.

The three weeks of post-petition work was not consideration for the lump

sum payments; that work was consideration for the payment of salaries which

appellants received in full. As we stated in Amarex :

[T]he right to priority does not necessarily depend on the fact that the
obligation to pay the bonus did not arise until after the
commencement of bankruptcy proceedings. As the cases indicate,
what is crucial is what consideration supports the bonus, and whether
such consideration, or a portion of it, was pre-petition services.

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Amarex , 853 F.2d at 1531.

The consideration supporting appellants’ right to the lump sum cash

payments was the mutual promises contained in their respective employment

contracts. That consideration was rendered entirely pre-petition and cannot

support appellants’ claim for administrative priority. No part of the consideration

for the lump sum payments was supplied to the debtor in possession.

Further, there is no evidence that the consideration for the lump sum

payments was beneficial to the debtor in possession in the operation of the

business. In fact, four days after appellants were terminated, the debtor in

possession moved the bankruptcy court for permission to reject the employment

contracts and eventually did so. Thus, appellants’ agreement to forego other

employment opportunities to work for CFS in return for the promise of the lump

sum payments was of no benefit to the estate. The lump sum payments were not

actual, necessary costs and expenses of preserving the estate. See 11 U.S.C.

§ 503(b)(1)(A).

Appellants cite Teamsters Local No. 310 v. Ingrum (In re Tucson Yellow

Cab Co.) , 789 F.2d 701, 704 (9th Cir. 1986), in which the Ninth Circuit held that

severance pay in lieu of notice was entitled to administrative priority. That case,

driven largely by equitable concerns, is distinguishable. In Tucson Yellow Cab , a

collective bargaining agreement between the taxi drivers and the company

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provided for two weeks notice prior to termination or severance pay in lieu of

notice. The clear intent of the parties was to compensate the drivers for at least

two weeks before termination, either by providing them with two weeks notice,

after which the drivers would presumably work two more weeks and be paid, or to

pay them two weeks severance pay and terminate them immediately. The pay in

lieu of notice was clearly a component of compensation. Here, in contrast,

appellants were paid their normal wages for the three weeks they worked

post-petition. The lump sum cash payments were not “wages, salaries, or

commissions for services rendered after the commencement of the case.” See 11

U.S.C. § 503(b)(1)(A).

Here, as in Mammoth Mart , the salaries paid appellants fully compensated

them for their post-petition services to the debtor in possession. “The claims for

[the lump sum payments] are based entirely upon [consideration supplied] by

appellants to the debtor, and, as such, are not entitled to priority.” Mammoth

Mart , 536 F.2d at 955.

The judgment of the United States District Court for the Northern District

of Oklahoma is AFFIRMED.

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