In re Metro Fulfillment, Inc.

• Decision Date: 04 June 2003
• Docket Number: Bankruptcy No. SV 01-21763-AG.,BAP No. CC 02-1527-BMoP.
• Citation: 294 B.R. 306
• Parties: In re METRO FULFILLMENT, INC., Debtor. Maria Gonzalez; Maria Hernandez, Appellants, v. David Gottlieb, Chapter 7 Trustee, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

294 B.R. 306

In re METRO FULFILLMENT, INC., Debtor Maria Gonzalez; Maria Hernandez, Appellants, v. David Gottlieb, Chapter 7 Trustee, Appellee.

BAP No. CC 02-1527-BMoP.

Bankruptcy No. SV 01-21763-AG.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted on March 19, 2003.

Filed June 4, 2003.

Cassandra Stubbs, Bet Tzedek Legal Services, North Hollywood, CA, for Maria Gonzalez and Maria Hernandez.

David L. Neale, Levene, Neale, Bender & Rankin, L.L.P., Los Angeles, CA, for David Gottlieb, Ch. 7 Trustee.

Before BRANDT, MONTALI, and PERRIS, Bankruptcy Judges.

OPINION

BRANDT, Bankruptcy Judge.

In this appeal, we are asked to determine whether claims for penalty wages under California law for failure to timely pay postpetition wages, and for paying postpetition wages with checks drawn on insufficient funds, are entitled to administrative priority under § 503(b)(1)(A).¹ The bankruptcy court concluded that they were not, reasoning that penalty wages were not actual and necessary costs of preserving the estate. We REVERSE.

I. FACTS

The facts are undisputed. Metro Fulfillment, Inc. ("Debtor") operated a warehouse in Newhall, California. It filed for chapter 11 protection on 18 December 2001.

Maria Hernandez and Maria Gonzalez (jointly, "Claimants") were employed in Debtor's packing and shipping department at minimum wage. Hernandez was employed from 7 November 2001 until she quit on 13 February 2002. Debtor owed her several weeks' wages. She received one check for regular wages dated 18 January 2002 for $440.78, which was returned for insufficient funds ("NSF"); Debtor has never paid Hernandez these wages.

Gonzalez was employed from 5 October 2001 until she quit on 5 May 2002. Debtor also owed her several weeks of wages. She received a check dated 18 January 2002 for $222.22, which was returned NSF; Debtor has never paid Gonzalez these wages.

Claimants filed separate but similar motions for payment of administrative claims under § 503(b)(1)(A), and entitlement to priority under § 507(a)(3)(A) for postpetition wages and penalties under California Labor Code ("CLC") §§ 203 and 203.1:²

                Regular Wages Penalty Total
                  Hernandez    $1139.82         $3240.00    $4379.82
                  Gonzalez     $2654.61         $3240.00    $5894.61
                

The penalty figure is a combination of waiting time penalty, calculated at the employee's regular daily wage for a maximum of 30 days (CLC § 203), and the NSF check penalty of $1620 each (CLC § 203.1).³

Debtor did not object to Claimants' motions for administrative priority for regular postpetition wages, but did as to the penalty wages. The case was converted to chapter 7 and David K. Gottlieb ("Trustee") was appointed trustee before the bankruptcy court ruled. He objected to the allowance of the penalty wages as an administrative expense.

On 26 September 2002, the bankruptcy court entered a memorandum denying administrative priority, concluding:

The penalty wages imposed under [CLC] §§ 203 and 203.1 do not constitute actual and necessary wages in preserving the estate under 11 U.S.C. § 503(b)(1)(A), and therefore do not qualify as an administrative expense subject to priority payment under 11 U.S.C. § 507(a)(1). Also, they do not constitute a priority wage claim under 11 U.S.C. § 507(a)(3)(A). At most, these penalty wages constitute a general unsecured claim, lacking any priority under Section 507.

Memorandum, 26 September 2002, page 4.

Claimants timely appealed.

II. JURISDICTION

The bankruptcy court had jurisdiction via 28 U.S.C. § 1334 and § 157(b)(1) and (b)(2)(B), and we do under 28 U.S.C. § 158(c).

III. ISSUE

Whether the bankruptcy court abused its discretion in denying Claimants' motions for allowance of penalty wages as an administrative expense claim under § 503(b)(1)(A).

IV. STANDARD OF REVIEW

We review the bankruptcy court's order allowing or disallowing an administrative claim for abuse of discretion. Teamsters Indus. Sec. Fund v. World Sales, Inc. (In re World Sales, Inc.), 183 B.R. 872, 875 (9th Cir. BAP 1995). A bankruptcy court necessarily abuses its discretion if it bases its decision on an erroneous view of the law or clearly erroneous factual findings. Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405, 110 S.Ct. 2447, 110 L.Ed.2d 359 (1990).

We review issues of statutory interpretation de novo. Industrial Comm'n of Ariz. v. Solot (In re Sierra Pacific Broadcasters), 185 B.R. 575, 577 (9th Cir. BAP 1995).

V. DISCUSSION

A. Administrative Priority

Section 507(a)(1) accords administrative expenses of a bankruptcy estate first priority, and § 726(b) makes chapter 7 administrative expenses prior to those from chapter 11 in cases converted from chapter 11 to chapter 7. Section 503(b)(1)(A) allows for administrative expenses, "including ... 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

must be the actual and necessary costs of preserving the estate for the benefit of its creditors. The terms "actual" and "necessary" are [to be] construed narrowly ....

Burlington N.R.R. Co. v. Dant & Russell, Inc. (In re Dant & Russell, Inc.), 853 F.2d 700, 706 (9th Cir.1988) (citations omitted).

To establish an administrative expense claim, a claimant must show that the debt:

(a) arose from a transaction with the debtor in possession as opposed to the preceding entity...; and

(b) directly and substantially benefitted the estate.

Microsoft Corp. v. DAK Indus., Inc. (In re DAK Indus., Inc.), 66 F.3d 1091, 1094 (9th Cir.1995).

The bankruptcy court denied Claimants' motions to allow the penalty wages as administrative claims under § 503(b)(1)(A), reasoning that the penalty wages did not represent compensation for actual services rendered, and thus were not ordinary or necessary costs benefitting or preserving the estate.

1. Application of Palau

The bankruptcy court relied on National Labor Relations Bd. v. Walsh (In re Palau Corp.), 18 F.3d 746, 750 (9th Cir.1994), reasoning that the penalty wages are not wages for the performance or furnishing of actual services, nor were they damages payable under § 503(b)(1)(A). In Palau, the debtor laid off an employee prepetition. Postpetition, the National Labor Relations Board (NLRB) obtained an administrative ruling that the layoff violated the National Labor Relations Act. The NLRB then filed an administrative claim for postpetition net back pay and benefits. The bankruptcy court denied the request to so classify the claim, and we affirmed, as did the Ninth Circuit. The Circuit adopted our rationale:

[W]here the employee does not work during the postpetition period, there is no postpetition benefit to the estate and no postpetition conduct to justify the allowance of backpay as an administrative expense. Simply stated, taking money from the estate to pay back wages to an individual who did not work is detrimental, not beneficial to the estate.

Palau, 18 F.3d at 751 (quoting National Labor Relations Bd. v. Walsh (In re Palau Corp.), 139 B.R. 942, 944 (9th Cir. BAP 1992)).

The bankruptcy court's reliance on Palau was misplaced. Although the claim there represented back pay and benefits relative to a postpetition period, the claim itself arose out the debtor's prepetition conduct. Accordingly, the claim did not arise "from a transaction with the debtor in possession as opposed to the preceding entity." Given that the claim failed the first prong of the DAK test, the Palau court's comments regarding benefit to the estate may be dicta. Even if they are not, the Palau analysis is inapplicable here, where the claims arose out of the postpetition acts of Claimants and the debtor in possession.

2. The Reading Exception

In Reading Co. v. Brown, 391 U.S. 471, 483, 88 S.Ct. 1759, 20 L.Ed.2d 751 (1968), the Supreme Court held that damages arising from negligent acts of a receiver were appropriately classified as administrative priority expenses, as costs ordinarily incident to the operation of the debtor's business. The Court concluded the statutory objective of fairness dictated the result, as the injured party "did not merely suffer injury at the hands of the business: it had an insolvent business thrust upon it by operation of law." Id. at 478, 88 S.Ct. 1759. With this decision, the Court broadened the interpretation of the term "actual and necessary" beyond typical operating costs: "`[A]ctual 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, 88 S.Ct. 1759.

Although decided under the Bankruptcy Act, the Reading exception survived the enactment of the Code. Texas Comptroller of Public Accounts v. Megafoods Stores, Inc. (In re Megafoods Stores, Inc.), 163 F.3d 1063, 1071 (9th Cir.1998).

The Trustee contends that the Reading exception does not apply, because the exception applies only to tort-like conduct, citing Oregon Department of Human Resources v. Witcosky (In re Allen Care Centers, Inc.), 96 F.3d 1328, 1331 (9th Cir.1996). In that case, the court held that costs incurred by a state trustee in closing down a nursing home were not entitled to administrative priority. The court summarily dismissed the argument that the costs fell within the Reading exception as ordinarily incident to the running of a business: "[W]e have held that the rule of Reading applies only in cases involving `postpetition tort-like conduct,' and the Department's expenses resulted, not from any postpetition wrongdoing, but simply from Allen Care's insolvency." 96 F.3d at 1331 (citing Palau, 18 F.3d at 751). Allen Care has little application here. The Ninth Circuit was not deciding in that case how to classify costs arising out of a debtor in possession's (or trustee's) violation of 28 U.S.C. § 959(b). As will be seen below, when squarely presented...