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Bar News - July 16, 2014

Federal Practice & Bankruptcy: Contempt Is Futile: First Circuit Gives Penalties Priority in Bankruptcy


Not far from the scenic Androscoggin River, pictured here, was a bulk oil storage facility in Gorham, NH, that was found not in compliance with state environmental laws. Enforcement was complicated by the company filing for Chapter 11 reorganization after compliance action began. Photo by Lorna Colquhoun.
Contempt penalties for post-bankruptcy non-compliance can be considered priority administrative expenses, according to the First Circuit’s 2013 decision in Munces’s Superior Petroleum Products Inc. v. State of New Hampshire Department of Environmental Services.

If allowed to grow, penalties like these can effectively sink a reorganization. In Munce’s, the First Circuit held that a New Hampshire oil distributor who ignored a superior court order to close would be required to pay contempt penalties as a cost of doing business during the Chapter 11 case.

Munce’s Superior Petroleum Products (Munce’s) owned and operated above-ground bulk oil storage tank facilities in New Hampshire that were not in compliance with state environmental laws and court orders, both before and during bankruptcy proceedings. The non-compliant facilities were located in close proximity to the Androscoggin River, along Route 16 in Gorham.

The state brought an action for injunctive relief and assessment of civil penalties against Munce’s in superior court and alleged that the company’s violations presented significant environmental harm and hazard to public safety. Munce’s assented to an injunction order that required it to bring the Gorham facilities into full compliance with the law within 90 days, or take the facilities out of service in accordance with tank closure regulations. When Munce’s missed the deadlines, the state moved for contempt.

Before the superior court ruled, however, Munce’s filed a Chapter 11 petition. At the state’s request, the bankruptcy court declared that the stay did not apply and that the superior court could rule on the contempt motion.

The superior court issued an order requiring closure within 10 days and that penalties would accrue against Munce’s at $1,000 per day if it did not comply with the order. Munce’s did not comply and continued to operate. Six months later, the superior court ordered penalties on contempt in the amount of $192,000.

The state then moved the bankruptcy court to allow the penalties as administrative priority claims against Munce’s. The bankruptcy court granted the motion and the US District Court affirmed on appeal.

Under federal law, bankruptcy debtors must operate their businesses and property in compliance with applicable state laws during bankruptcy. 28 USC § 959(b). No one is allowed to maintain a nuisance or violate the law while in bankruptcy. Ohio v. Kovacs, 469 US 274, 285 (1985). The obligation to comply with environmental laws for property the debtor still owns and possesses is abundantly clear. Cumberland Farms Inc. v. Florida Dep’t of Envtl. Protection, 116 F.3d 16, 19-20 (1st Cir. 1997).

Under Bankruptcy Code Section 503, expenses that are actual and necessary to preserve the estate will be allowed as administrative expenses. Under a strict reading of Section 503 and the case law that developed around it, administrative expense priority is only allowed to the extent that the claimant can demonstrate the expense produced a benefit to the estate. In the 1968 case Reading Co. v. Brown, however, the Supreme Court made an exception for the debtor’s post-petition costs of doing business and out of fairness to those not voluntarily doing business with the debtor.

Following Reading Co., the First Circuit held that a fine assessed for violation of an injunction was allowable as an administrative expense because fairness to the claimants dictated that the post-petition portion of the fine sanctioning the debtor for violating a pre-petition injunction must be allowable as an administrative expense. Spunt v. Charlesbank Laundry Inc. (In re Charlesbank Laundry Inc.), 755 F.2d 200, 201 (1st Cir. 1985).

Charlesbank Laundry granted administrative priority to a compensatory penalty. This may have left open the question of how to treat a penalty that was not based on actual harm or damage. In Cumberland Farms Inc. v. Florida Department of Environmental Protection, the First Circuit expanded the Reading Co. fairness doctrine to include a civil penalty assessed post-petition for a violation of an environmental law regarding petroleum storage tank facilities based solely on regulatory violations.

The court accepted that Reading Co. and Charlesbank Laundry were controlling and reasoned that in a regulated business, such fines were “ordinarily incident to operation of a business.” The court concluded that it “would be fundamentally unfair to allow Cumberland Farms to flout Florida’s environmental protection laws and escape paying a penalty for such behavior.”

In Munce’s, the First Circuit agreed with the bankruptcy court and the district court and held that the post-bankruptcy contempt penalties constituted administrative expenses in the case under section 503. It found that Reading Co., Charlesbank Laundry, and Cumberland Farms were “decisive” and resulted in affirmance. The court rejected Munce’s argument that because the contempt arose pre-petition, it should all be treated as a pre-bankruptcy “transaction,” and thus ineligible for administrative expense priority. It also rejected Munce’s argument that because the contempt penalties were punitive and not compensatory, no priority under the Reading/Charlesbank/Cumberland Farms “fairness doctrine” was appropriate.

Munce’s makes clear that post-petition violations of state court orders will result in administrative expense priority in bankruptcy, even where the activity involved initially began pre-petition. The ramifications of this, from an enforcement perspective, can be very serious.

To confirm a plan, a debtor must pay the administrative expenses in full at confirmation. If this number is allowed to grow, the debtor will need large amounts of cash. The dynamic informs the government, the state courts, and the debtor that bankruptcy is not a haven from law enforcement and that, if the agency is persistent and methodical about enforcement, those efforts will be rewarded either with compliance or liquidation.

Peter Roth is a senior assistant New Hampshire attorney general in the Environmental Protection Bureau and has practiced in bankruptcy law since 1990.

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