All creditors are not created equal under bankruptcy law. The U.S. Bankruptcy Code prioritizes different classes of unsecured creditors, so that administrative expenses related to the bankruptcy case are usually paid first, followed by various other priority claims related to employee compensation, certain sales of goods, and taxes. After priority claims are paid, the general unsecured creditors share any remaining scraps.
This arrangement favors creditors having administrative expense claims. The statutory definition of administrative expenses is complicated, but typical administrative expenses can be summarized as “the actual, necessary costs and expenses of preserving” the debtor’s assets. This definition was recently tested when a state environmental agency asserted that punitive fines against a bankrupt debtor were priority administrative claims.
Munce’s Petroleum Products, Inc. v. N.H. Department of Environmental Services involved a fuel distributor operating above-ground storage tanks. The fuel tanks violated state law because they lacked secondary containment systems. The N.H. Department of Environmental Services (DES) notified the distributor of these violations at least four times, but the distributor took no action. DES filed suit in state court in 2010 to shut down the tanks. The state court ordered the distributor to bring its facilities into compliance or close them. The distributor disobeyed the order. DES returned to court in 2011, seeking a contempt order against the distributor. While the court’s decision was pending, the distributor filed for Chapter 11 bankruptcy, delaying the state court action while continuing operations as a debtor in possession.
It’s Fine
DES secured bankruptcy court permission to continue its contempt proceedings in state court, and on Sept. 19, 2011, the state court ordered the distributor to shut down the tanks or pay a $1,000-per-day fine. The distributor remained noncompliant. DES pressed forwaRd. and on April 12, 2012, the state court assessed a $192,000 fine against the distributor, $1,000 for each day of noncompliance.
DES next asked the bankruptcy court to classify the $192,000 fine as an administrative priority claim, and the bankruptcy court agreed. The distributor appealed to the U.S. Court of Appeals for the First Circuit, which handles federal appeals from Massachusetts, Maine, New Hampshire, Rhode Island and – oddly – Puerto Rico.
The distributor argued that the fines should be classified as general unsecured claims without priority, because they arose from statutory violations existing before the distributor went bankrupt. The court disagreed, noting that the debtor incurred the fines when it disobeyed a state court order issued after it filed bankruptcy. The court observed that fines for violating environmental laws are an incidental cost of doing business, bankrupt debtors do not have “carte blanche to ignore” environmental laws, and allowing a debtor to do so would be “fundamentally unfair.” Accordingly, the court affirmed that the fines were priority administrative claims.
The distributor here evokes little sympathy, having defied environmental laws and court orders. Nevertheless, the violations did not cause serious environmental harm. The real victims are the distributor’s other unsecured creditors, whose claims diminished as the distributor amassed nearly $200,000 in DES fines having priority status. In hindsight, one can argue that those creditors should have intervened to shut down the illegal fuel tanks before fines were imposed. The general creditors had notice of the problem when DES sought bankruptcy court permission to pursue the state court contempt proceedings. Unfortunately, hindsight is clearer than foresight.
Christopher R. Vaccaro is an attorney at Looney & Grossman LLP in Boston. His email address is cvaccaro@lgllp.com.
