MAXON ENGINEERING SERVICES INC and G&G Developers Corp. ("G&G")

UNITED STATES BANKRUPTCY COURT
DISTRICT OF PUERTO RICO
In re: Bk. No. 04-04781-MWV
Chapter 11
Maxon Engineering Services, Inc.,
Debtor
MEMORANDUM OPINION
The Court has before it “PREPA’s Rule 9023 Motion to Reconsider, Alter, Amend and for
Additional Findings.” The Court agreed to reconsider its Memorandum Opinion dated September 13,
2005, wherein the Court found the Puerto Rico Electric Power Authority (“PREPA”) to have violated the
automatic stay. Maxon Engineering Services, Inc. (the “Debtor”) filed its opposition on September 28,
2005, and the Court held a hearing on September 29, 2005.
JURISDICTION
This Court has jurisdiction of the subject matter and the parties pursuant to 28 U.S.C. §§ 1334
and 157(a) and the “Standing Order of Resolution for Bankruptcy Cases” dated July 19, 1994 (Torruella,
C.J.). This is a core proceeding in accordance with 28 U.S.C. § 157(b).
FACTS
Debtor, an engineering company, performed work prepetition on several of PREPA’s projects
pursuant to contracts entered into by Debtor and PREPA. During the course of this relationship Debtor
assigned its rights to payment under approximately ten of these contracts to Banco Bilbao Vizcaya
Argentaria (“BBVA”). PREPA assented in writing to the assignments. PREPA was to write the
checks, payable for the Debtor’s work, in the names of both the Debtor and BBVA. Prior to the Debtor
filing its bankruptcy petition, PREPA, on several occasions, violated the assignment agreements by
disbursing checks payable only in the Debtor’s name. As a result, BBVA did not receive payment on
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these occasions. BBVA has since filed suit against PREPA in Puerto Rico state court seeking damages
of $2,015,249.86.
The Debtor filed its petition for chapter 11 bankruptcy on May 5, 2004. After that date, the
Debtor continued to provide services and equipment to PREPA. The amounts owing Debtor for this post-
petition work exceeds $500,000 (the “post-petition funds”). PREPA placed an administrative hold on the
payment of the post-petition funds owed the Debtor while PREPA investigated BBVA’s claim.
DISCUSSION
In its Memorandum Opinion, the Court found PREPA to be in violation of the automatic stay for
placing an administrative hold on the post-petition payments due the Debtor. Along the way, the Court
found that PREPA was attempting to set off post-petition funds against a prepetition claim (i.e., PREPA’s
claim against the Debtor in response to BBVA’s claim against PREPA). As the Court stated, a creditor
cannot use post-petition funds to set off prepetition claims. See United States v. Holden, 258 B.R. 323,
327 (D. Vt. 2000); In re Ruiz, 146 B.R. 877 (Bankr. S.D. Fla. 1992). PREPA now advances two
arguments: first, that its claim against the Debtor is a post-petition claim, rather than a prepetition claim;
and, second, that its administrative hold on the post-petition funds is not a violation of the automatic stay.
PREPA argues that its claim is a post-petition claim because PREPA was unaware that it had a
claim against the Debtor until BBVA asserted a claim against PREPA, which occurred after the Debtor
filed bankruptcy. Essentially, PREPA argues that because it did not become aware of its potential liability
to BBVA, and hence did not know it had a claim against the Debtor, until after the Debtor filed its
bankruptcy petition, PREPA did not have an enforceable right to payment, and therefore it had no “claim”
under the bankruptcy code. PREPA relies on In the Matter of M. Frenville Co., Inc. for the proposition
that a bankruptcy claim does not arise until a right to payment, i.e., cause of action, arises under
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1 Unless otherwise noted, all statutory section references herein are to the Bankruptcy Reform
Act of 1978, as amended, 11 U.S.C. § 101, et seq.
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applicable state law. 744 F.2d 332 , 337 (3rd Cir. 1984). Frenville, however, represents a narrow
definition of the term “claim” that has been followed by virtually no court outside the Third Circuit. See,
e.g., In re Hemingway Transport, Inc., 954 F.2d 1, 8 & n.9 (1st Cir. 1992); Grady v. A.H. Robins Co,
Inc., 839 F.2d 198, 201 (4th Cir. 1988); In re Jensen, 995 F.2d 925, 930 (9th Cir. 1993); In re Parker, 313
F.3d 1267, 1269–70 (10th Cir. 2002).
The language of section 101(5)1 itself urges a broader reading of “claim.” Section 101(5) casts a
wide net:
(5) "claim" means—
(A) right to payment, whether or not such right is reduced to judgment,
liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal,
equitable, secured, or unsecured; or
(B) right to an equitable remedy for breach of performance if such breach gives
rise to a right to payment, whether or not such right to an equitable remedy is reduced to
judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or
unsecured.
This broad wording was apparently intended to ensure that “all legal obligations of the debtor, no matter
how remote or contingent, will be able to be dealt with in the bankruptcy case.” H.R. Rep. No. 95-595, at
309 (1977), as reprinted in 1978 U.S.C.C.A.N. 5963, 6266; accord S. Rep. 95-989, at 22 (1978), as
reprinted in 1978 U.S.C.C.A.N. 5787, 5808.
Courts have employed several tests to determine when a bankruptcy claim arises. According to
the conduct test “the focus should be on the time when the acts giving rise to the alleged liability were
performed . . . . Thus, for federal bankruptcy purposes, a prepetition ‘claim’ may well encompass a
cause of action that, under state law, was not cognizable until after the bankruptcy petition was filed.” In
re Johns-Manville Corp., 57 B.R. 680, 690 (Bankr. S.D.N.Y. 1986); see also In re A.H. Robins Co., Inc.,
63 B.R. 986, 993 (Bankr. E.D. Va. 1986) (holding that the claim arose when claimant inserted the Dalkon
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Shield, rather than upon manifestation of injury). The narrower prepetition relationship test requires
“some prepetition relationship, such as contact, exposure, impact, or privity, between the debtor’s
prepetition conduct and the claimant.” In re Piper Aircraft Corp., 162 B.R. 619, 627 (Bankr. S.D. Fla.
1994) (employing the test in a products liability situation). Finally, the fair contemplation test, a derivation
of the prepetition relationship test, requires a degree of relationship sufficient that the claimant could fairly
contemplate that a claim would arise. See In re Nat’l Gypsum Co., 139 B.R. 397, 408–09 (Bankr. N.D.
Tex. 1992).
This Court finds that PREPA has a prepetition claim under all three tests. All of the contracts at
issue between PREPA and the Debtor were entered into prepetition. PREPA assented to all of the
assignments to BBVA prepetition. All checks erroneously made payable solely to the Debtor were
disbursed by PREPA prepetition. Hence, a significant and enduring relationship was established among
the parties prepetition, and all of the Debtor’s conduct giving rise to Debtor’s alleged liability to PREPA
was performed prepetition. Also, having signed approximately ten assignment agreements and disbursed
numerous checks, PREPA had sufficient knowledge so as it could have fairly contemplated that the
alleged liability might arise from its erroneous check disbursements. It is immaterial whether PREPA was
aware of BBVA’s claim against it before the Debtor filed its bankruptcy petition. The relationships had
been established, and the conduct giving rise to liability had been completely performed such that PREPA
could have anticipated some liability for its repeated mistaken actions. The Court thus finds that PREPA
had a prepetition claim against the Debtor, and, therefore, PREPA has no right to set off this prepetition
claim against post-petition funds owed the Debtor. A creditor cannot use post-petition funds to set off
prepetition claims. See United States v. Holden, supra; In re Ruiz, supra.
Remaining is PREPA’s contention that the Court erred in concluding that PREPA’s
administrative hold of funds owed the Debtor violated section 362(a)(3). Section 362(a)(3) stays “any act
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to obtain possession of property of the estate or of property from the estate or to exercise control over
property of the estate.” PREPA argues that its placement of an administrative hold on the post-petition
funds owed the Debtor is not an act to obtain or exercise control over property of the Debtor’s estate.
That the accounts receivable owed the Debtor are property of the estate is not disputed. The issue is
whether the administrative hold is an act stayed by section 362(a)(3). PREPA cites Citizens Bank of
Maryland v. Strumpf, 516 U.S. 16, 116 S. Ct. 286, 133 L. Ed. 2d 258 (1995), as “holding that an
administrative hold placed on the payment of a debt owed to a creditor in bankruptcy does not violate the
automatic stay.” (PREPA’s motion to reconsider). The Court disagrees; Strumpf is not so broad. In
Strumpf, the Court held that a bank did not violate the automatic stay by placing a temporary
administrative hold on the debtor’s bank account while it sought relief from the automatic stay. Strumpf,
516 U.S. at 21. A central fact in Strumpf, though, was that the bank had a valid right of setoff. See id.
(describing the bank’s administrative hold as “the temporary refusal of a creditor to pay a debt that is
subject to setoff against a debt owed by the bankrupt”) (emphasis added). The conclusion that there
must be at least a colorable claim of setoff rights in order for a temporary administrative freeze to not be
violative of the automatic stay is further supported by the Court’s stated question presented of “whether
the creditor of a debtor in bankruptcy may, in order to protect its setoff rights, temporarily withhold
payment of a debt that it owes to the debtor in bankruptcy without violating the automatic stay imposed by
11 U.S.C. § 362(a).” Id. at 17 (emphasis added); see also In re Holden, 217 B.R. 161, 166 (D. Vt. 1997)
(“Under Strumpf, a temporary freeze on funds in which a creditor has a good faith basis for asserting a
right of setoff, and which is promptly followed by a request for relief from stay, maintains the status quo
and therefore may not violate the automatic stay.”). In In re Harris, the court found a creditor’s reliance
on Strumpf to be misplaced because the creditor, like PREPA in the instant case, “placed an
administrative hold upon post-petition funds rather than pre-petition funds.” 260 B.R. 753, 755 (Bankr. D.
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Md. 2001). Accordingly, the court held that the creditor’s administrative hold violated the automatic stay
because it “had no right to set off.” Id. at 756. PREPA’s administrative hold is further distinguishable
from the temporary hold in Strumpf, where the bank sought relief from the automatic stay five days after
initiating the hold. In contrast, PREPA filed its motion for relief from the automatic stay after this Court
issued its Memorandum Opinion finding PREPA’s hold to be in violation of the stay. For the reasons
stated above, PREPA’s administrative hold on post-petition funds owed the Debtor is a violation of
section 363(a)(3).
CONCLUSION
PREPA’s motion to reconsider is denied. This opinion constitutes the Court’s findings and
conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. The Court will issue
a separate final order consistent with this opinion.
DATED this 21st day of November, 2005, at Manchester, New Hampshire.
/s/ Mark W. Vaughn
Mark W. Vaughn
Chief Bankruptcy Judge
District of New Hampshire
Sitting by designation
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