State of Texas v. Lowe

• Court: Court of Appeals for the Fifth Circuit
• Decided: August 28, 1998
• Docket: 97-50584
• Status: Published

Opinion

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT _______________

No. 97-50584 _______________

IN THE MATTER OF H.L.S. ENERGY CO., INC.,

Debtor.

STATE OF TEXAS,

Appellee,

VERSUS

JOHN PATRICK LOWE, Trustee,

Appellant.

_________________________

Appeal from the United States District Court for the Western District of Texas _________________________

August 28, 1998

Before JOLLY, SMITH, and BARKSDALE, Circuit Judges.

JERRY E. SMITH, Circuit Judge:

At issue is the priority to be afforded a state's claim on a

bankrupt estate, for costs incurred by the state in satisfaction of

the estate's post-petition environmental obligations. Because we

conclude that such costs are “actual, necessary costs and expenses

of preserving the estate,” see 11 U.S.C. § 503(b)(1)(A), we affirm the district court's order that they be given priority as

administrative expenses.

I.

In 1991, H.L.S. Energy Co., Inc. (“HLS”), filed for bankruptcy

reorganization under chapter 11. A large part of its assets

consisted of operating interests in oil and gas wells in Texas,

some of which were productive and some not. The chapter 11

trustee's basic plan of reorganization seems to have been to rid

HLS's viable assets of the burden posed by its unviable ventures.

This he achieved by selling off that which was profitable.

In 1994, once most or all of HLS's valuable assets had been

sold, the bankruptcy proceeding was converted from a chapter 11

reorganization to a chapter 7 liquidation. In this appeal, the

chapter 7 trustee, John Lowe, challenges the priority of a claim by

the State of Texas arising out of the chapter 11 proceeding.

During the pendency of the chapter 11 proceeding, the state

brought an informal enforcement action against the bankrupt estate

in order to secure its compliance with certain environmental

regulations. Specifically, the Texas Railroad CommissionSSwhich

oversees all oil and gas production in the stateSSsought to require

HLS to plug certain inactive oil wells in which HLS had the sole

operating interest. The action was brought pursuant to 16 TEX.

ADMIN. CODE § 3.9 (1998) (Tex. R.R. Comm'n, Plugging), which requires

that “[p]lugging operations on each dry or inactive well must be

2 commenced within a period of one year after drilling or operations

cease.”1

The wells had ceased production at various dates, some before

and some after initiation of the chapter 11 proceeding. None,

however, had been inactive for more than one year prior to the

bankruptcy.

At the time, the bankrupt estate had insufficient funds with

which to plug the wells. After some negotiation, the chapter 11

trustee reached an agreement with the state whereby the state would

plug the wells and charge the cost of plugging to the bankrupt

estate. The state also agreed to waive substantial penalties that

had accumulated while the wells remained unplugged. The cost to

the state of plugging the wells was $41,808, for which it claimed

reimbursement.

During the chapter 7 liquidation, the state asserted that its

claim should be entitled to priority over those of other unsecured

creditors under 11 U.S.C. § 503(b)(1)(A), as a necessary

administrative expense. The trustee disputed this

characterization. The bankruptcy court found, and the district

court agreed, that the state's claim should be entitled to

priority.

1 See also TEX NAT. RES. CODE ANN. § 89.011 (Vernon 1978) (“The operator of a well shall properly plug the well when required and in accordance with the commission's rules”); TEX NAT. RES. CODE. ANN § 89.121(a) (granting enforcement authority to the Commission).

3 II.

A.

The state argues that in the proceedings below, the trustee

waived his argument that the state's claim should not be entitled

to priority. Having reviewed the record, we disagree.

Throughout the proceedings, the trustee consistently and

steadfastly maintained that the state's claims should be entitled

only to general unsecured status. The state makes much of the

trustee's statement to the bankruptcy court that “if the Court is

inclined to grant administrative expense status to this claim, it

should be granted status only as a Chapter 11 administrative

expense claim because that is consistent with the terms of the

agreed order.”

This statement is not a waiver. Rather, the initial caveat

demonstrates that it is an argument in the alternative: Even if

the claim were to receive chapter 11 priority, the trustee argued,

it should not receive chapter 7 priority as well.2 Consequently,

the trustee's objection to the chapter 11 administrative expense

status of the state's claim was not waived and is properly

presented on appeal.

B.

2 The question whether the claim should be entitled to chapter 7 priority is no longer in dispute, for it appears that there is enough money to pay all the chapter 11 administrative claims.

4 The state asserts that the terms of the Agreed Order conferred

administrative priority on the state's claim, regardless of whether

bankruptcy law would have so characterized its claim. This

averment encounters two obstacles: First, it is far from certain

that the Agreed Order purported to confer such priority status on

the state's claim. Second, the trustee argues that he was never

party to that orderSSafter all, he had not even been appointed

trusteeSSand cannot be bound thereby. The state responds that the

creditors' committee was a party to the order and that, inasmuch as

Lowe now challenges the state's priority on behalf of those

creditors, he is bound by the acquiescence of his principals.

Rather than engage these arguments, we address the merits of

whether this claim may be afforded administrative expense priority

under the bankruptcy law. Because the state prevails on the

merits, the terms and effect of the Agreed Order with regard to the

administrative priority are of no consequence.

III.

The Bankruptcy Code provides that “the actual, necessary costs

and expenses of preserving the estate” are characterized as

administrative expenses, 11 U.S.C. § 503(b)(1)(A) (1994), entitled

to priority over the claims of other unsecured creditors, id.

§ 507(a)(1) (1994). In Reading Co. v. Brown, 391 U.S. 471, 485

(1968), the Court provided an expansive interpretation of what is

5 an “actual, necessary cost” entitled to priority, holding that

damages in negligence to a third party arising out of the

receiver's administration of the estate give rise to an “actual and

necessary cost.” “It is theoretically sounder . . . to treat tort

claims arising during [a bankruptcy] arrangement as actual and

necessary expenses of the arrangement rather than debts of the

bankrupt.” Id. at 483.

Reading has survived subsequent revisions to the Code, as the

underlying statutory provision was left essentially unchanged. See

In re Al Copeland Enters., 991 F.2d 233, 239 (5th Cir. 1993). The

question is whether Reading and § 503(b)(1)(A) apply here to

characterize the state's claims as administrative expenses, imbued

with priority status.

An “actual and necessary cost” must have been of benefit to

the estate and its creditors. See, e.g., In re Transamerican

Natural Gas Corp., 978 F.2d 1409, 1416 (5th Cir. 1992). This

requirement is in keeping with the conceptual justification for

administrative expense priority: that creditors must pay for those

expenses necessary to produce the distribution to which they are

entitled. See 3 DANIEL R. COWAN, BANKRUPTCY LAW AND PRACTICE

§ 12.23(e)(1), at 83 (6th ed. 1994). “That is, the costs of

salvage are to be paid.” Id. The “benefit” requirement has no

independent basis in the Code, however, but is merely a way of

testing whether a particular expense was truly “necessary” to the

6 estate: If it was of no “benefit,” it cannot have been

“necessary.” See LAWRENCE P. KING, ED., 4 COLLIER ON BANKRUPTCY

¶ 503.06[3][b] (15th rev. ed. 1998).

The trustee argues that the costs incurred by the state in

connection with plugging the unproductive wells did not “benefit”

the estate. Of course this is trueSSin the sense that the bankrupt

estate and its creditors would have been happy to abandon the

unproductive wells, leaving them unplugged in abdication of HLS's

obligations under Texas law. But bearing in mind that the

“benefit” requirement is simply a gloss on the underlying concept

of what is “necessary,” our notion of “benefit” cannot be limited

to the narrow sense that the trustee urges.

Under federal law, bankruptcy trustees must comply with state

law. See 28 U.S.C. § 959(b). Furthermore, a bankruptcy trustee

may not abandon property in contravention of a state law reasonably

designed to protect public health or safety. See Midlantic Nat'l

Bank v. New Jersey Dep't of Envtl. Protection, 474 U.S. 494, 507

(1986). And there is no question that under Texas law, the owner

of an operating interest is required to plug wells that have

remained unproductive for a year.3 See 16 TEX. ADMIN. CODE § 3.9

(1998) (Tex. R.R. Comm'n, Plugging). Furthermore, because the

3 The trustee asserts that the obligation to plug a well arises as soon as it becomes unproductive. He is incorrect as a matter of law. Operators are required to commence plugging within a year of the cessation of production. See TEX. NAT. RES. CODE ANN. § 89.011; 16 TEX. ADMIN. CODE § 3.9. Thus, prior to the passage of one year he may plug the wells, but after the passage of that year, he is in violation if he does not.

7 wells became inactive post-petition or after a year prior to the

petition, the plugging obligations on these wells accrued post-

petition. See id. Thus, a combination of Texas and federal law

placed on the trustee an inescapable obligation to plug the

unproductive wells, an obligation that arose during the chapter 11

proceedings.

The fulfillment of this, the estate's obligation, can only be

seen as a benefit to the estate. In this sense, the state's action

resembles the sort of “salvage” work that lies at the heart of the

administrative expense priority. No one would challenge the

expense of shoring up the sagging roof on a bankrupt's warehouse,

for example, where carpentry was needed to prevent further damage

to the structure or liability from injury to passers-by. Cf.,

e.g., 4 King, supra, ¶ 503.06[1] (examples of “proper” expenditures

including repairs and upkeep). The laws of Texas compelled action

in this case just as surely as would the laws of physics in that

one. The unplugged unproductive wells operated as a legal

liability on the estate, a liability capable of generating losses

in the nature of substantial fines every day the wells remained

unplugged.

This case is not unlike our decision in Al Copeland, in which

the chapter 11 debtor had failed to remit sales tax revenues it had

collected and were due to the state under Texas law. Furthermore,

Texas law required the debtor to pay interest on revenues collected

8 that remained unpaid. Because the trustee was required to manage

the estate in accordance with state law, see 28 U.S.C. §§ 959(b)

and 960, it had been required ab initio to remit the tax revenues.

Therefore, the interest that accrued as a result of his post-

petition decision not to pay was an administrative expense: an

“actual and necessary cost” comparable to the “damages resulting

from the negligence of the receiver” in Reading. See Al Copeland,

991 F.2d at 238-240 (quoting Reading, 391 U.S. at 485).

Just as the Al Copeland trustee was obligated under Texas law

to remit the sales tax revenues, the trustee here was obligated

plug the wells.4 The failure of the trustee in Al Copeland to

fulfill his state law obligations resulted in further liability

under state law, liability that was given priority as an

administrative expense. Similarly, the instant trustee's failure

to plug the wells resulted in the state's action in plugging them,

an action for which the bankrupt estate was obligated to pay.

This, too, must be given priority.

IV.

The trustee contends that the the chapter 11 trustee never

4 In fact, there is reason to believe that the decision to cease production on the wells was an economic one: The wells had been depleted to the point at which they cost more to operate than they produced revenue. Thus, the trustee likely could have avoided the need to plug the wells by resuming production, but made a rational economic calculation to cease production. Such a calculation, however, must include the cost of plugging operations as a cost of ceasing production.

9 “operated” the wells so as to render costs associated with the

wells of benefit to or necessary to his management of the estate.

Again, Texas law directly dictates otherwise.

Of course, the chapter 11 trustee never did anything with the

wells: The whole point of this case is that he neither produced

oil from nor plugged them. Still, the bankrupt estate possessed

the sole operating interest in the wells. Anyone possessing the

sole operating interest in an unproductive well surely would be

happy to abandon that interest, and the concomitant obligation to

plug that well. But he cannot, for Texas law requires well

operators to plug their wells when they are finished with

production. See TEX. NAT. RES. CODE ANN. § 89.011.

It therefore matters not whether the bankrupt estate produced

any oil or received any revenue from the wells. As the operator,

it was required to plug them.

V.

Because the plugging requirement here accrued post-petition,

we need not reach the question whether post-petition expenses for

the remediation of pre-petition environmental liabilities would

likewise constitute an administrative expense. But because we

conclude that the cost of plugging the wells in accordance with

Texas law was an “actual and necessary cost” of managing the

estate, we agree that such cost must be afforded priority as an

10 administrative expense. The order granting priority is AFFIRMED.