In re New York Trap Rock Corp.

• Decision Date: 06 March 1992
• Docket Number: Bankruptcy No. 90 B 21276-90 B 21286,90 B 21334 and 90 B 21335.
• Citation: In re New York Trap Rock Corp., 137 B.R. 568 (Bankr. S.D.N.Y. 1992)
• Parties: In re NEW YORK TRAP ROCK CORPORATION, Lone Star Industries, Inc., et al., Debtors. In re LONE STAR INDUSTRIES, INC., Debtor.
• Court: U.S. Bankruptcy Court — Southern District of New York

137 B.R. 568 (1992)

In re NEW YORK TRAP ROCK CORPORATION, Lone Star Industries, Inc., et al., Debtors In re LONE STAR INDUSTRIES, INC., Debtor.

Bankruptcy Nos. 90 B 21276-90 B 21286, 90 B 21334 and 90 B 21335.

United States Bankruptcy Court, S.D. New York.

March 6, 1992.

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Sills Cummis Zuckerman Radin Tischman Epstein & Gross, P.C., New York City, and Bonham Carrington & Fox, P.C., Houston, Tex., for Brown & Root, Inc.

Proskauer Rose Goetz & Mendelsohn, New York City, for debtors.

DECISION ON MOTION OF BROWN & ROOT, INC. FOR ORDER COMPELLING DEBTOR TO HONOR INDEMNIFICATION OBLIGATION, ASSUME DEFENSE OF LITIGATION AND REIMBURSE BROWN & ROOT FOR COSTS AND EXPENSES

HOWARD SCHWARTZBERG, Bankruptcy Judge.

Brown & Root, Inc. ("Brown & Root"), a general contractor and a creditor, has moved for an order compelling the debtor to (i) honor a prepetition indemnification agreement; (ii) assume the defense of litigation commenced against Brown & Root by a subcontractor for the debtor; and (iii) reimburse Brown & Root for costs and expenses incurred during the administration of this Chapter 11 case as an administrative priority claim. The Chapter 11 debtor in this case, Lone Star Industries, Inc., opposes the Brown & Root motion and contends that Brown & Root's indemnification claim gives rise to a prepetition unsecured claim and is not entitled to an administrative expense status. Additionally, the debtor asserts that it should not be compelled to assume a prepetition indemnification obligation by defending the litigation against Brown & Root in the United States District Court for the Northern District of Illinois, thereby elevating such prepetition claim to an administrative expense priority, nor should it be required to pay Brown & Root's litigation expenses other than pursuant to a plan of reorganization.

FINDINGS OF FACT

1. On December 10, 1990, Lone Star Industries, Inc., the debtor, filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code. The debtor continues to operate its business and manage its affairs as debtor-in-possession in accordance with 11 U.S.C. §§ 1107 and 1108.

2. Among the assets of the debtor's estate is a cement plant located in Oglesby, Illinois (the "Oglesby Plant"). On June 1, 1989, Brown & Root executed a contract with the debtor to act as construction manager for the modernization of the Oglesby Plant (the "Contract"). The Contract provided, inter alia, that: (i) Brown & Root, as agent for the debtor, would subcontract for various services to implement the modernization project on the Oglesby Plant; (ii) Brown & Root would not make any payments to vendors or subcontractors without the debtor's prior written approval and such payments would be made from a "zero-balance bank account" funded by the debtor; and (iii) Brown & Root would be indemnified and held harmless by the debtor if Brown & Root was subjected to any loss, damages, fines or penalties, or any cancellation fees because of such nonpayment. The indemnity was stated in paragraph 10.4 as follows:

CONTRACTOR shall not make any payments to vendors or subcontractors without OWNER\'s prior written approval. Should CONTRACTOR become subject to any loss, damages, fines or penalties, or any cancellation fees because of such non-payment, CONTRACTOR shall be indemnified and shall be held harmless by OWNER.

3. On August 10, 1990, Brown & Root, as agent for the debtor, executed a subcontract with International Riggers, Inc. ("IRI") for structural and mechanical work at the Oglesby Plant (the "IRI Subcontract").

4. On December 26, 1990, the debtor filed a motion for an Order (i) Authorizing Lone Star to Assume (a) an Executory Construction Contract and (b) an Executory Utility Contract; (ii) Approving the Terms of a Certain Construction Contract; and (iii) Authorizing Lone Star to Satisfy Certain PrePetition Obligations. In this three-pronged motion (the "Motion"), the debtor also sought authority to assume the IRI Subcontract and to cure defaults thereunder.

5. On January 9, 1991, the court entered an Order Approving the Motion which authorized the debtor to assume the IRI Subcontract. This assumption was unusual in that the debtor was not an original party to the IRI Subcontract. Moreover, Brown and Root, which was an original party to the IRI Subcontract, was bypassed when the debtor took it upon itself to assume a contract to which it was originally not a party. Upon assumption of the IRI Subcontract, the debtor agreed to cure the prepetition arrearages under the IRI Subcontract by paying twenty-five percent of the arrears within two days after the entry of the Order, and the balance in six equal monthly installments commencing on January 20, 1991.

6. The modernization project on the Oglesby Plant was estimated to be eighty-five percent complete on December 10, 1990, the date the debtor filed its bankruptcy petition filing date. In January of 1991, the debtor and Brown & Root executed a post-petition contract which provided that Brown & Root would perform such further construction management, procurement, engineering and other administrative services as required to complete the Oglesby Project. There was no indemnification clause in this post-petition contract with Brown & Root.

7. Despite having assumed the IRI Subcontract, the debtor failed to cure the arrearages as prescribed by the court's Order approving the Motion. In an attempt to recover such arrearages from Brown & Root, on May 13, 1991, IRI filed its Complaint against Brown & Root in Civil Action No. 91-C-20148 in the United States District Court for the Northern District of Illinois.

8. By letter dated July 18, 1991, the attorney for Brown & Root wrote to the attorneys for the debtor and stated that inasmuch as the debtor assumed two of the major subcontracts for the modernization of the debtor's Oglesby cement plant, it was requested that the debtor file appropriate pleadings seeking authority for the bankruptcy court to approve the assumption of the Brown & Root contract.

9. By letter dated August 30, 1991, Brown & Root requested that the debtor: (i) honor the indemnification obligation in the prepetition contract; (ii) assume defense of the IRI Litigation; and (iii) reimburse Brown & Root for all of its costs and expenses in defense of said Litigation. To date, the debtor has refused to act upon Brown & Root's requests.

DISCUSSION

The narrow issue in this case is whether or not the debtor's prepetition obligation to indemnify Brown & Root for expenses incurred by Brown & Root as agent and general contractor for the debtor also triggered a post-petition administrative expense claim in favor of Brown & Root because of the debtor's post-petition conduct. To qualify as an administrative expense, the claim must satisfy section 503(b)(1)(A), which accords administrative expense status for "the actual, necessary costs and expenses of preserving the estate ... for services rendered after the commencement of the case...." 11 U.S.C. § 503(b)(1)(A). Manifestly, expenses incurred by a debtor in possession in attempting to rehabilitate the business during reorganization are within the pale of 11 U.S.C. § 503. Reading Co. v. Brown, 391 U.S. 471, 475, 88 S.Ct. 1759, 1761, 20 L.Ed.2d 751 (1968); In re Hemingway Transport, Inc., 954 F.2d 1 (1st Cir.1992); Trustees of Amalgamated Ins. Fund v. McFarlin's, Inc., 789 F.2d 98, 101 (2d Cir. 1986); In re Jartran, Inc., 732 F.2d 584 (7th Cir.1984); Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 536 F.2d 950 (1st Cir.1976); In re Drexel Burnham Lambert Group, Inc., 134 B.R. 482 (Bankr. S.D.N.Y.1991); In re Chateaugay Corporation, 102 B.R. 335 (Bankr.S.D.N.Y.1989).

Generally, a claim for an administrative expense status will qualify under 11 U.S.C. § 503 if the right to payment arose from a post-petition transaction with the debtor estate rather than from a prepetition transaction with the debtor, and the conduct giving rise to the payment was beneficial to the estate of the debtor. Hemingway Transport, 954 F.2d at 10; Jartran, 732 F.2d at 587; Mammoth Mart, 536 F.2d at 954. The burden of proving entitlement to an administrative expense priority rests with the party requesting it. Hemingway Transport, 954 F.2d at 10; Drexel Burnham, 134 B.R. at 489. Additionally, administrative expense priorities are to be narrowly construed to foster the paramount principle in bankruptcy of equitable distribution among creditors. McFarlin's, 789 F.2d at 100; Jartran, 732 F.2d at 586; Mammoth Mart, 536 F.2d at 953. In sum, a two-fold test is applicable in determining administrative expense status under 11 U.S.C. § 503(b)(1)(A): (1) the claim must arise out of a post-petition transaction between the creditor and the trustee or debtor in possession and (2) the claim is allowable only to the extent the consideration supporting the claimant's right to payment was both supplied to and beneficial to the post-petition estate in the operation of the business. McFarlin's, 789 F.2d at 101; Jartran, 732 F.2d at 587; Mammoth Mart, 536 F.2d at 954.

In the instant case, the prepetition contract between the debtor and Brown & Root, dated June 1, 1989, specifically provided that the debtor, as principal, would indemnify Brown & Root, as agent and general contractor, for any loss, damages, fines or penalties with respect to the construction work at the debtor's cement plant in Oglesby, Illinois. The fact that post-petition defaults by the debtor on the assumed IRI Subcontract may have triggered the debtor's prepetition obligation to indemnify Brown & Root for losses or damages does not mean that Brown & Root's contingent claim for indemnification was elevated and transformed into a post-petition administrative claim. Initially, it should be observed that Brown & Root's claim is contingent because there was no proof that Brown & Root made any payments for which indemnification accrued. Under...