DAK Industries, Inc., In re

• Decision Date: 02 October 1995
• Docket Number: No. 94-55029,94-55029
• Parties: , Bankr. L. Rep. P 76,648, 95 Cal. Daily Op. Serv. 7694, 95 Daily Journal D.A.R. 13,159 In re DAK INDUSTRIES, INCORPORATED, Debtor. MICROSOFT CORPORATION, Appellant, v. DAK INDUSTRIES, INCORPORATED; Official Committee of Unsecured Creditors; The Tokai Bank, Limited, Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1091

66 F.3d 1091

27 Bankr.Ct.Dec. 1185, Bankr. L. Rep. P 76,648,

95 Cal. Daily Op. Serv. 7694,

95 Daily Journal D.A.R. 13,159

In re DAK INDUSTRIES, INCORPORATED, Debtor.

MICROSOFT CORPORATION, Appellant, v. DAK INDUSTRIES, INCORPORATED; Official Committee of

Unsecured Creditors; The Tokai Bank, Limited, Appellees.

No. 94-55029.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 2, 1995.

Decided Oct. 2, 1995.

Michael S. Kogan, Arter & Hadden, Los Angeles, CA, for appellant.

Joseph A. Eisenberg, Timothy T. Read, and Werner Disse, Levene & Eisenberg, Los Angeles, CA, for appellee DAK Industries, Incorporated.

Steven N. Bloom and Gary Owen Caris, Frandzel & Share, Los Angeles, CA, for appellee The Tokai Bank, Ltd. and Los Angeles Agency.

Thomson Young and Harry D. Hochman, Pachulski, Stang, Ziehl & Young, Los Angeles, CA, for Official Creditors Committee.

Appeal from the United States District Court for the Central District of California.

Before FLETCHER, BRUNETTI, and T.G. NELSON, Circuit Judges.

BRUNETTI, Circuit Judge:

Microsoft Corporation appeals from an order of the district court affirming the bankruptcy court's denial of its administrative expense claim filed pursuant to 11 U.S.C. Sec. 503. We have jurisdiction under 28 U.S.C. Sec. 158(d), and we affirm.

FACTS AND PROCEEDINGS BELOW

In April 1991, Microsoft, a distributor of computer software, and DAK Industries, Inc., a distributor of computer hardware, entered into a "License Agreement" granting DAK certain nonexclusive, worldwide "license rights" to Microsoft's Word for Windows software (Word). The agreement gave DAK the right to adapt Word to enable it to run on computer systems sold by DAK, to copy Word, and to distribute and license Word to consumers during a specified term. DAK also received the right to accept updates and new versions of Word, as well as the right to distribute copyrighted documentation that explained how to use Word. As a practical matter, the agreement provided that Microsoft would furnish DAK with a master disk containing Word, and that DAK would copy the program and load it onto computer hardware units, which it then sold to end consumers.

The agreement provided that DAK would pay a "royalty rate" of $55 per copy of Word that it distributed. Upon signing the agreement, DAK became obligated to pay Microsoft a "minimum commitment" of $2,750,000

in five installments, regardless of how many copies of Word it sold. The payment schedule was:

                1)  Signing of agreement:               $250,000
                2)  First payment date:                 $406,250
                3)  3 months after first payment date:  $697,917
                4)  6 months after first payment date:  $697,917
                5)  9 months after first payment date:  $697,917
                

The first payment date depended upon when DAK first sold a copy of Word to a consumer. The term of the agreement expired one year after the first payment date.

DAK's $2,750,000 minimum commitment paid Microsoft royalties at the $55 per unit price for the distribution of 50,000 copies of Word. DAK could sell any and all of those copies to consumers at any time during the term. The agreement provided that if DAK sold more copies than those paid for by the minimum commitment, DAK would pay Microsoft $55 for each additional copy sold. However, if DAK sold fewer copies than those paid for by the minimum commitment, Microsoft would not refund any of the commitment. Microsoft did not perfect a security interest in any of DAK's property, which might have protected it against DAK's failure to pay the entire minimum commitment in the event of bankruptcy.

Sometime between July and December of 1991, the parties amended the agreement by reducing the royalty rate to $45. As a result of the amendment, the minimum commitment paid royalties for the sale of more than 50,000 copies of Word.

The first payment date was December 30, 1991. In accordance with the payment schedule, DAK paid the first three installments, totaling $1,354,167. On June 11, 1992, DAK filed a petition for bankruptcy. The debtor has not paid the final two installments, totaling $1,395,833.

On December 1, 1992, Microsoft moved in the bankruptcy court for an order compelling the debtor to assume or reject the executory contract with Microsoft. On January 12, 1993, Microsoft filed a motion for the payment of an administrative expense, claiming it should be compensated for the debtor's post-bankruptcy petition "use" of the license agreement, because the debtor continued to distribute Word.

On February 3, 1993, the bankruptcy court denied Microsoft's administrative expense claim. The court concluded that the payment structure of the agreement was more analogous to payments on a sale of goods than to royalty payments for the continuing use of an intellectual property. As such, the debt was a prepetition unsecured claim, not a postpetition administrative expense claim. The court also concluded that the agreement was an executory contract, and that the debtor had until May 4, 1993, to assume or reject the agreement.

In April 1993, Microsoft moved for reconsideration of the denial of its administrative expense claim. The bankruptcy court denied that motion on June 16, 1993.

The debtor rejected the agreement on May 4, 1993. The parties agree that DAK had sold approximately 13,244 copies of Word prior to filing for bankruptcy on June 11, 1992. They also agree that the debtor sold approximately another 7,600 copies between June 11, 1992, and January 21, 1993, a date one week before the bankruptcy court hearing on Microsoft's administrative expense claim. The record does not reflect how many copies of Word the debtor sold between January 21, 1993, and May 4, 1993, the date when it formally rejected the agreement and stopped selling Word. ¹

Microsoft appealed the bankruptcy court's denial of its administrative expense claim to the district court. The district court concluded that the debtor had received benefits

from its postpetition distribution of Word. However, the court concluded that the payment schedule resembled installment payments for the sale of goods, not periodic royalties for the use of intellectual property. Therefore, the obligations for the amounts due under the agreement were incurred prepetition. The court also concluded that Microsoft was neither induced to nor continued to provide software units at its expense after the filing of the petition. Accordingly, Microsoft had provided no postpetition consideration to debtor. The court rejected Microsoft's administrative expense claim, thereby leaving the remaining amount due under the agreement as a prepetition, unsecured claim.

STANDARD OF REVIEW

The role of the district court and this court are basically the same in the bankruptcy appellate process. In re Christian Life Center, 821 F.2d 1370, 1373 (9th Cir.1987). Therefore, we review the bankruptcy court decision directly. Id. We review the bankruptcy court's findings of fact for clear error, and its conclusions of law de novo. In re Comer, 723 F.2d 737, 739 (9th Cir.1984).

ANALYSIS

Under the bankruptcy code, an administrative expense claim has priority over other unsecured claims. 11 U.S.C. Sec. 503 provides in pertinent part:

(a) An entity may file a request for payment of an administrative expense.

(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....

The burden of proving an administrative expense claim is on the claimant. In re Sinclair, 92 B.R. 787, 788 (Bank.S.D.Ill.1988). The claimant must show that the debt asserted to be an administrative expense

(1) arose from a transaction with the debtor-in-possession as opposed to the preceding entity (or, alternatively, that the claimant gave consideration to the debtor-in-possession); and (2) directly and substantially benefitted the estate.

In re White Motor Corp., 831 F.2d 106, 110 (6th Cir.1987). The bankruptcy court has broad discretion to determine whether to grant such a claim. In re Dant & Russell, Inc., 853 F.2d 700, 706 (9th Cir.1988). In order to keep administrative costs to the estate at a minimum, "the actual, necessary costs and expenses of preserving the estate," Sec. 503(1)(A), are construed narrowly. In re Palau, 139 B.R. 942, 944 (9th Cir. BAP 1992), aff'd, 18 F.3d 746 (9th Cir.1994).

In this case, the debtor rejected an executory contract without ever assuming it. Under 11 U.S.C. Sec. 365(g)(1), for purposes of bankruptcy proceedings, that rejection constitutes breach of the contract immediately prior to the date on which the bankruptcy petition was filed. Nonetheless, after the petition, the debtor continued to distribute copies of the software provided under that contract. The estate directly and substantially benefited from these postpetition sales of Word. Therefore, Microsoft is entitled to an administrative expense claim if the debt outstanding on the contract arose after the petition or if Microsoft provided consideration to the debtor after the petition. See White Motor Corp., 831 F.2d at 110. Otherwise, Microsoft is entitled only to a prepetition, unsecured claim.

Microsoft argues that this transaction should be viewed as an agreement granting DAK the use of intellectual property. Accordingly, Microsoft claims that the debt arose after the petition as periodic payments for use of the property became due. Microsoft also argues that even though the transaction was initiated prior to the petition, Microsoft provided consideration after the petition by continuing to make the intellectual property available for the debtor's use. Characterized this way, the transaction is analogous to a debtor's postpetition use of leased property under an agreement signed prepetition. Such use gives rise to an administrative expense claim for the payment of rent....