Source: http://www.mondaq.com, May 13, 2013
By: Vicki Harding, Pepper Hamilton LLP
A company (Route 21) bought property from the debtor (MHC) in the mid-1980s that turned out to be contaminated. After the debtor filed bankruptcy in 2009, Route 21 attempted to protect its rights against MHC by moving for specific performance of the debtor’s environmental obligations under a settlement agreement and seeking to have the costs of cleanup treated as an administrative expense.
Route 21’s claim for costs already incurred was over $1 million, and it estimated additional costs of $6.6 million, with MHC responsible for $1.65 million. The bankruptcy court denied the motion for specific performance, denied administrative expense status, and disallowed future cleanup costs entirely. Route 21 appealed to the district court.
Circumstances developed over 25 years as follows:
Specific Performance: The district court agreed with the bankruptcy court that the settlement agreement was an executory contract that was deemed rejected. That still left the question of whether the equitable remedy of specific performance was a “claim” that could be discharged in bankruptcy in dealing with a rejection claim.
Under Section 101(5) of the Bankruptcy Code, a claim includes a “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment.” The court analyzed a series of cases and concluded that there is a distinction between (1) environmental laws that only authorize requiring a debtor to clean up a contaminated site and (2) those that also include an option for the government or a private party to clean up the contamination itself and seek monetary reimbursement from a debtor. The first category did not constitute a claim, while the second category did.
This case was an example of the second category – both because Route 21 had a contractual right to reimbursement and because the environmental laws it could invoke included the option to perform the cleanup and seek reimbursement. The court also concluded that the claims could be monetized since the debtor’s obligations were largely a matter of indemnity, which inherently involve payments, and the costs were capable of being estimated.
Administrative Priority: The district court also agreed that Route 21’s claims were not entitled to administrative expense status. The goal is to convince people to do business with the debtor while a bankruptcy case is ongoing. To be entitled to administrative expense status, the court concluded that (1) the expense must arise out of a transaction between the creditor and the debtor in possession (as opposed to a prepetition transaction with the debtor), and (2) the transaction must be beneficial to the debtor in possession. In this case, the transactions were clearly prepetition, and the debtor no longer owned the property so that the remediation did not benefit the estate.
Future Cleanup Costs: Section 502(e)(1)(B) of the Bankruptcy Code provides that “the court shall disallow  any claim for reimbursement or contribution  of an entity that is liable with the debtor on or has secured the claim of a creditor, to the extent that…  such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim for reimbursement or contribution.”
First, it was clear that “reimbursement” includes indemnity, and Route 21’s claims came within the scope of this section.
With respect to whether Route 21 was co-liable, the court did acknowledge one case that construed this section as applying only to claims involving joint or secondary, rather than direct, liability of the creditor. (See In re Allegheny Int’l Inc., 126 B.R. 919 (W.D. Pa. 1991), aff’d without opinion, 950 F.2d 721 (3rd Cir. 1991).) In addition to distinguishing the facts of Allegheny from MHC, the court disagreed with the case and rejected the distinction.
As to contingency, even though liability may have been established, the amount that was to be paid had not yet been determined, so the claim remained contingent.
The bottom line is that Route 21 was left only with a general unsecured claim for ~$1 million. During oral argument, it was acknowledged that it might receive only a 1% distribution on that amount. While acknowledging that this may seem harsh, the court characterized this as a controversy between creditors about the allocation of limited resources:
Stripped to their essence, Route 21’s arguments to the bankruptcy court and this court are attempts to skip the line of creditors and get paid in whole dollars – whether by obtaining specific performance or by receiving administrative priority.
Although there are circumstances in which a debtor will be compelled to deal with environmental problems notwithstanding its bankruptcy, there is certainly no assurance that this will be the case. Any buyer who is relying on a seller to take responsibility for environmental conditions should think twice about how to structure the obligations so that there is some assurance that the buyer will not be left holding the bag.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Specific Questions relating to this article should be addressed directly to the author.