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Parties Involved:
Enterasys Networks, Inc.
Appellee
Native American Systems, Inc.
Not Party
M. Stephen Peters
Appellant

Document Text:

UNITED STATES BANKRUPTCY APPELLATE PANEL

OF THE TENTH CIRCUIT

IN RE NATIVE AMERICAN

SYSTEMS, INC., doing business as

Native American Sales Inc., doing

business as Native American Co., doing

business as Native American

Companies,

Debtor.

BAP No. CO-06-036

M. STEPHEN PETERS, Trustee,

Appellant,

Bankr. No. 02-10387-EEB

 Chapter 7

v.

ENTERASYS NETWORKS, INC.,

Appellee.

JUDGMENT

Filed September 29, 2006

Before BOHANON, CORNISH, and THURMAN, Bankruptcy Judges.

This case originated in the United States Bankruptcy Court for the District

of Colorado.

The judgment of that court is AFFIRMED.

For the Panel:

Barbara A. Schermerhorn, Clerk of Court

By:

Deputy Clerk

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 1 of 12
* The parties did not request oral argument, and after examining the briefs

and appellate record, the Court has determined unanimously that oral argument

would not materially assist in the determination of this appeal. See Fed. R.

Bankr. P. 8012. The case is therefore ordered submitted without oral argument.

FILED

U.S. Bankruptcy Appellate Panel

of the Tenth Circuit

September 29, 2006

Barbara A. Schermerhorn

Clerk PUBLISH

UNITED STATES BANKRUPTCY APPELLATE PANEL

OF THE TENTH CIRCUIT

IN RE NATIVE AMERICAN

SYSTEMS, INC., doing business as

Native American Sales Inc., doing

business as Native American Co., doing

business as Native American

Companies,

Debtor.

BAP No. CO-06-036

M. STEPHEN PETERS, Trustee,

Appellant,

Bankr. No. 02-10387-EEB

 Chapter 7

v. OPINION

ENTERASYS NETWORKS, INC.,

Appellee.

Appeal from the United States Bankruptcy Court

for the District of Colorado

Submitted on the briefs:*

Virginia M. Dalton of Pearlman & Dalton, P.C., Denver, Colorado, for Appellant.

Alex Darcy of Askounis & Borst, P.C. and Kenneth J. Buechler of Sender &

Wasserman, P.C., Denver, Colorado, for Appellee.

Before BOHANON, CORNISH, and THURMAN, Bankruptcy Judges.

THURMAN, Bankruptcy Judge.

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 2 of 12
1 In re Miller, 284 B.R. 734, 736 (10th Cir. BAP 2002) (“An order disposing

of an objection to a claim is a final order for purposes of 28 U.S.C. § 158(a)(1).”).

2 28 U.S.C. § 158(a)(1), (b)(1), and (c)(1). Fed. R. Bankr. P. 8002.

3 In re Busetta-Silvia, 314 B.R. 218, 222 (10th Cir. BAP 2004).

-2-

The Debtor’s Trustee appeals the bankruptcy court’s allowance of an

administrative expense to Enterasys Networks, Inc. (“Enterasys”) in the amount

of $40,340.20, pursuant to 11 U.S.C. § 503(b). This appeal involves the question

of whether a bankruptcy court may allow a Chapter 11 administrative claim for

services requested by the debtor of a creditor, where the creditor stood ready to

provide the same but the debtor did not actually use the service. The bankruptcy

court found in favor of the creditor, whereupon the Chapter 7 Trustee appealed. 

For the reasons set forth hereafter, we affirm.

I. APPELLATE JURISDICTION

The Trustee timely filed a notice of appeal from the bankruptcy court’s

March 23, 2006, Order Allowing Administrative Expense Claim, which is a final

order for the purposes of appeal.1

 Since neither party to this appeal elected to

have the appeal heard by the United States District Court for the District of

Colorado, this Court has jurisdiction to hear it.2

II. ISSUE AND STANDARD OF REVIEW

The single issue on appeal is whether the bankruptcy court properly treated

Enterasys’s service contracts as administrative expenses under § 503(b). This

Court reviews a bankruptcy court’s interpretation of § 503(b) de novo.3

III. BACKGROUND

The Debtor is in the business of reselling technical service contracts to

governmental entities. The Debtor contracts to provide a customer with technical

services, then contracts with vendors of such services, such as Enterasys, to

service the Debtor’s customer. The price the Debtor’s customer pays for the

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 3 of 12
4 The Debtor paid Enterasys a total of $46,349.47 for the two contracts, and received $4,612.00 from LLL and $47,459.00 from DOE, for a total of

$52,071.00. Thus, the Debtor’s gross profit on these two contracts was

$5,721.53.

-3-

service contract is higher than the price paid by the Debtor to the vendor, such

that the Debtor makes a profit on each service contract sold. Vendors agree to

provide telephonic technical support for a stated period of time for a set price. 

Thus, the price paid by the customer is the same whether the customer regularly

uses the vendor’s services or does not use them at all. Similarly, once the Debtor

has paid a vendor for the contract, its liability to the vendor has been satisfied,

regardless of its customer’s use of the vendor’s services. However, in the event

that a vendor failed to provide the agreed services, the customer would have a

breach of contract claim against the Debtor, based on the Debtor’s agreement to

“provide” the services. In that event, the Debtor had the right, under its contract

with the vendor, to cancel the contract and receive back a pro rata portion of the

contract price.

In 2001, the Debtor renewed two one-year service contracts with two of its

customers, Department of Energy (“DOE”) and Lawrence Livermore Laboratories

(“LLL”). The Debtor likewise renewed its contracts with Enterasys for the

provision of services to those customers, by purchase orders dated December 14,

2001 and September 28, 2001, respectively.4

 The LLL contract renewal began on

October 1, 2001, and the DOE contract renewal began on December 1, 2001. The

Debtor filed a petition for Chapter 11 relief on January 11, 2002, after having

received full contract payment from LLL in November 2001. The Debtor, which

continued to operate as a debtor-in-possession, received full contract payment

from DOE on March 2, 2002. Neither LLL nor DOE ever sought technical

services during the relevant contract terms, though Enterasys stood ready to

provide them.

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 4 of 12
5 Enterasys pro-rated its contracts with the Debtor by dividing the contract

price by 365 to get a per diem rate and multiplying that number by the number of

days from the filing of the petition to the end of each contract period.

6 In re Mid Region Petroleum, Inc., 1 F.3d 1130, 1133 (10th Cir. 1993)

(citing In re Amarex, 853 F.2d 1526, 1530 (10th Cir. 1988)).

7 Mid Region, 1 F.3d at 1132. 

-4-

On the same day that it filed its bankruptcy petition, January 11, 2002, the

Debtor paid Enterasys for both service contracts by one cashier’s check, issued

and obtained by the Debtor that day. The Debtor mailed the check to Enterasys,

which cashed it approximately five days later. One year later, on January 14,

2003, the Debtor’s case was converted to Chapter 7. The newly appointed

Trustee successfully sought to avoid the January 2002 payment to Enterasys, on

the ground that it was an avoidable transfer pursuant to 11 U.S.C. §§ 549 and 550. 

Enterasys repaid the estate and filed a motion to treat that portion of its service

contracts attributable to the Chapter 11 time period as an administrative expense,

pursuant to 11 U.S.C. § 503(b).5

 The bankruptcy court granted Enterasys’s

motion, and the Trustee appealed.

IV. DISCUSSION

Section 507(a)(2) grants priority to “administrative expenses allowed under

section 503(b) of this title.” Section 503(b)(1)(A) defines “the actual, necessary

costs and expenses of preserving the estate” as administrative expenses. The

Tenth Circuit Court of Appeals (“Tenth Circuit”) has held that in order to be

treated as an administrative expense, “the expense must: (1) arise out of a

transaction between the creditor and the bankrupt’s trustee or debtor-inpossession; and (2) benefit the debtor-in-possession in the operation of the

business.”6

 The party claiming entitlement to administrative expense priority

bears the burden of proving that the claim is so entitled.7

 The Trustee contends

that Enterasys’s claim fails to satisfy either prong of this test. 

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 5 of 12
8 Amarex, 853 F.2d at 1530 (second alteration in original) (internal quotation

marks omitted). 

9 Mid Region, 1 F.3d at 1134 (internal quotation marks omitted).

10 The parties apparently agree that payment made to Enterasys constitutes

“inducement” for its performance. However, the Trustee contends that the record

fails to establish that such inducement came from the debtor-in-possession, as

opposed to the pre-petition debtor, since there is no evidence as to whether the

cashier’s check was issued before or after the petition was filed. In a Joint PreTrial Statement submitted to the bankruptcy court by the Trustee and Enterasys,

the parties stipulated that the “transfer was postpetition.” Joint Pretrial

Statement at 3, ¶ 23, in Appellant’s Appendix at App-75. Given the additional

facts that (1) the check was not received or cashed by Enterasys for several days,

(2) no attempt was made to prevent or dissuade Enterasys from cashing it, and (3)

the Debtor quite obviously knew when it obtained the check that a bankruptcy

petition was imminent, we are hard pressed to find that payment, and thus

inducement, was not made post-petition. Nonetheless, we do not believe that the

Debtor’s inducement of Enterasys’s performance is limited to the single act of 

payment and, therefore, it is unnecessary to resolve this issue either way.

-5-

We discuss each of these requirements separately, keeping in mind that

“[s]tatutory priorities are to be narrowly construed [b]ecause the presumption in

bankruptcy cases is that the debtor’s limited resources will be equally distributed

among his creditors.”8

 Moreover, “[t]he policy behind giving priority to

administrative expenses in Chapter 11 proceedings is to encourage creditors to

supply necessary resources to debtors post-petition.”9

A. Transaction with the Debtor

The Trustee argues that payment of Enterasys on the day the Debtor filed

its bankruptcy petition was not a transaction with the debtor, as required by Mid

Region and Amarex, but was simply payment by the pre-petition debtor of a prepetition debt.10 However, Enterasys’s contracts with the Debtor, though entered

pre-petition, did not terminate upon the Debtor’s payment but remained executory

agreements, subject to the Debtor’s acceptance or rejection pursuant to 11 U.S.C.

§ 365(a). The Debtor neither assumed nor rejected the Enterasys contracts, which

terminated according to their terms during the Debtor’s Chapter 11 case. In any

event, pre-petition contracts may be treated as administrative expenses to the

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 6 of 12
11 See Amarex, 853 F.2d at 1531 (“[W]hat is crucial is what consideration

supports the [administrative expense], and whether such consideration, or a

portion of it, was pre-petition services.”). 

12 No. 05-1017, 2006 WL 2522471 (10th Cir. Sept. 1, 2006).

13 Id. at *6.

14 Id. at *6 n.4.

-6-

extent that the Debtor receives post-petition consideration for them.11 To the

extent that Enterasys’s provision of services was induced by the Debtor, postpetition, it constitutes a “transaction with the Debtor.”

The Court of Appeals for the Tenth Circuit recently revisited administrative

priority and the “Amarex test” in Peters v. Pikes Peak Musicians Assoc. (In re

Colorado Springs Symphony Orchestra Assoc.).

12 In that case, a musicians’

association asserted a claim for wages, pursuant to the parties’ collective

bargaining agreement, in the orchestra’s bankruptcy case. After first finding that

11 U.S.C. § 1113 (creating protections for collective bargaining claims) did not

“trump” the priority scheme of §§ 503 and 507, the Court considered whether the

musicians’ claims met the “transaction” and “beneficial consideration” elements

of Amarex. Although the transaction element typically requires “affirmative

action from the debtor-in-possession to either (1) accept the prior agreement

between the debtor and claimant, or (2) agree to a new contract,” the Court found

that in the collective bargaining context, such action is prohibited by § 1113.13

Thus, in the collective bargaining context, it is necessary to focus on the postpetition conduct of the claimant, rather than that of the debtor-in-possession, and

the Court specifically did not consider “whether the Orchestra here induced the

musicians to remain available to perform . . . thereby implicitly affirming the

collective bargaining agreement . . . .”14 However, finding that “the service

specifically bargained for was availability,” the Court found that “it was possible

for the musicians to comply with the agreement (and be entitled to full

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 7 of 12
15 Id. at *7.

16 Id. 

-7-

compensation) even if they never played.”15 Therefore, the Court concluded that

“by foregoing other opportunities and remaining ready, willing, and able to play,

the musicians performed ‘services’ under the terms of the contract” and had

satisfied the transaction element of expense priority.16

In this case, all of the Debtor’s conduct throughout the contract terms

indicated an intent to retain the benefit of the Enterasys contracts. First, the

Debtor had payment issued to Enterasys on the day it filed its petition, then made

no attempt to stop Enterasys’s use of that payment, nor even to notify Enterasys

of the pending bankruptcy proceedings. Second, the Debtor neither assumed nor

rejected the Enterasys contracts, and instead merely acquiesced in Enterasys’s

providing of services. This both provided a direct benefit to the Debtor, since it

was able to retain the profit made on the contracts’ resale, and deprived Enterasys

of the opportunity to protect its own interests. Finally, the Debtor did not notify

its customers, LLL and DOE, that the service contracts it had provided them

would be terminated, which would have required a refund to them of most of their

contract payments. Instead, the Debtor continued to operate its business of

contract resale up to and beyond the end of the Enterasys contract terms. Thus, it

appears that Enterasys’s performance was induced by the Debtor post-petition.

B. Benefit to Debtor

The Trustee principally argues that the Enterasys contracts did not

“benefit” the Debtor in the operation of its business. We disagree. The Debtor’s

business was resale of technical services contracts. The Debtor could not have

performed the service contracts itself, and its profit was therefore dependent upon

the provision of services by providers such as Enterasys. Had Enterasys failed to

responsibly carry out its duties under the contracts, the Debtor would have faced

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 8 of 12
17 Since the LLL payment was received pre-petition, the Trustee contends that

there can be no administrative priority on that claim. However, since the DOE

payment was received post-petition, the Trustee contends that, at most,

administrative priority could be given to the portion of that claim that falls

between the petition and payment, an interval of not quite two months. 

-8-

breach of contract claims by its customers, potential increased costs in connection

with “covering” the services not supplied by Enterasys and, perhaps worst, loss of

its goodwill in the industry. Similarly, had the Debtor rejected the Enterasys

contracts during their terms, it would have had to find another source of coverage

for its customers or cause them to make additional unsecured claims on the

Debtor’s estate. Either way, the estate would have been depleted, and the

likelihood of a successful reorganization would have been significantly

diminished.

The Trustee nonetheless argues that the Enterasys contracts did not benefit

the Debtor because the services were provided to third parties and, therefore, the

Debtor’s benefit ceased once it received payment from its customers.17 This

position requires too narrow of a definition of “benefit,” and is not supported by

the Mid Region case, on which the Trustee relies. In Mid Region, the Tenth

Circuit held that post-petition rental charges for freight cars that were retained by

the debtor, but not used, were not entitled to priority treatment since the cars

provided no benefit to the debtor. Significantly, the debtor was in possession of

the cars pre-petition, did not continue to pay rent post-petition, and was never

requested to either pay for or return the cars. Additionally, the trustee moved to

reject the rental contract within a reasonable period of time. In finding that the

claim was not entitled to priority, the court noted that “mere possession” of

property by the Debtor was not necessarily a “benefit,” and also noted that the

creditor “could have moved at any time after [the debtor] filed its petition to

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 9 of 12
18 Mid Region, 1 F.3d at 1133.

19 Peters, 2006 WL 2522471, at *7. The Peters Court’s conclusion that the

musicians’ availability was “essential” to a successful reorganization was based,

in part, on the “unique talents” of musicians and the “special chemistry” of an

orchestra. Id. However, we do not believe that the Court meant thereby to limit a

conclusion of beneficial consideration to such unique circumstances. Where, as

here, a claimant’s services significantly improve a debtor’s chances of a

successful reorganization, we believe that Peters strongly leads to the conclusion

that the claimant here, Enterasys, has satisfied the consideration requirement for

administrative priority. 

20 Id. at *7 n.5.

-9-

require the trustee to accept or reject . . . thereby mitigating its losses.”18

Unlike Mid Region, the present case does not involve the mere continued

possession of unused property by the Debtor. The Debtor’s conduct indicates a

desire to retain the technical services that Enterasys provided, rather than mere

passive possession of property. Also, transfer of the consideration in Mid Region,

the freight cars, was completed pre-petition, whereas Enterasys’s consideration,

the provision of technical services, continued on a daily basis well beyond filing

of the petition.

In Peters, with respect to the beneficial consideration element, the Court of

Appeals focused on the fact that the orchestra had initially endeavored to survive

its financial problems by attempting a reorganization and that the availability of

the musicians was “essential to the success” of that effort.19 The Court

distinguished Mid-Region on the basis that, whereas “the Orchestra was actively

seeking to preserve its business,” the debtor in Mid-Region “had already ceased

its business operations and therefore never made use of the railroad cars.”20 The

reasoning of Peters is persuasive in the present case. Enterasys’s continued

availability to provide service to Debtor’s customers was beneficial to Debtor’s

estate by allowing it the opportunity to attempt a reorganization.

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 10 of 12
21 142 B.R. 640 (S.D.N.Y. 1992).

22 Id. at 642 (monthly sub-sublease payments would have conferred a postpetition benefit to the estate by the sublessor). 

-10-

Similarly, the Trustee’s reliance on In re CIS Corp.

21 for the proposition

that pre-petition payment in full by the Debtor’s customers eliminates any postpetition benefit to the estate is misplaced. In CIS, the debtor leased computer

equipment to a third party, which subsequently subleased the equipment back to

debtor, which then sub-subleased the equipment to yet another entity. The district

court upheld the bankruptcy court’s denial of administrative priority to the

original lessee’s claim for unpaid sublease payments, on the basis that it had not

conferred a benefit on the estate because the debtor’s sub-sublease of the

equipment had been entirely prepaid pre-petition. Thus, when the petition was

filed, the debtor no longer had either any equipment or any right to payment for

that equipment. In the present case, the consideration flowing from Enterasys to

the estate is neither property nor payment for property. Rather, it is the provision

of, or the availability to provide, technical service to the Debtor’s customers on

its behalf. In this way, the consideration flowed from Enterasys to the Debtor on

an ongoing basis, which even the CIS court held would have been sufficient for

administrative priority.22

 In this case, the Trustee argues that Enterasys did not, in fact, provide any

consideration because: (1) consideration, if any, was supplied to third parties

rather than to the Debtor, and (2) the customers never requested any technical

services from Enterasys. As discussed previously, the Trustee’s contention that

the Debtor did not itself benefit from the providing of services to its customers is

unrealistic. Although it did not receive the kind of tangible benefit typically

granted administrative priority, the Debtor clearly needed and wanted Enterasys

to provide, or at least be available to provide, service to its customers. Thus,

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 11 of 12
-11-

under the facts of this case, we hold that the Debtor’s business was benefitted by

Enterasys’s providing of service to the Debtor’s customers. Therefore, the only

remaining issue is whether Enterasys actually provided services, given that

service was not requested by the Debtor’s customers.

The bankruptcy court likened Enterasys’s contracts to contracts of

insurance. We agree. Just as an insurance policy protects an insured from a

specified loss, technical service contracts protect customers from the

consequences of technical malfunction. Just as an insured cannot demand a

refund of health insurance premiums if he does not need medical care, the

Debtor’s customers cannot demand a refund of their contract payment because

they were able to get by without technical advice. Likewise, just as an

independent insurance agency benefits from the coverage provided to its

customers by an insurer, the Debtor benefits from the availability of service

provided to its customers by Enterasys, without respect to the customers’ actual

use. Finally, under Peters, where the bargained-for service is availability to

perform, availability is performance.

V. CONCLUSION

Either the providing of services under its contracts with the Debtor, or its

standing ready, willing and able to provide those services, constitutes a

transaction between Enterasys and the debtor-in-possession that benefitted the

Debtor in the operation of its business. Therefore, we affirm the bankruptcy

court’s allowance of the amount of $40,340.20 to Enterasys as a Chapter 11

administrative expense, pursuant to 11 U.S.C. §§ 503(b) and 507(a)(2). 

BAP Appeal No. 06-36 Docket No. 31 Filed: 09/29/2006 Page: 12 of 12