Court Opinion

ID: 6795
Source: CourtListenerOpinion
Date Created: 2010-04-25 05:21:23+00
Date Added: 2024-06-11T16:46:13.112947
License: Public Domain

IN THE UNITED STATES COURT OF APPEALS

                       FOR THE FIFTH CIRCUIT

                       _____________________

                            No. 93-3581
                       _____________________

IN RE UNITED STATES ABATEMENT CORPORATION,
a/k/a U.S.A. Corp.,
                              Debtor

UNITED STATES ABATEMENT CORP.,
a/k/a U.S.A. Corp.,
                                 Appellant,

          v.

MOBIL EXPLORATION & PRODUCING U.S., INC.,
as agent for Mobil Oil Exploration & Producing Southeast, Inc.
and Mobil Exploration and Producing North America, Inc.,

                                 Appellee.

_________________________________________________________________

           Appeal from the United States District Court
              for the Eastern District of Louisiana
_________________________________________________________________

                        (November 23, 1994)

Before KING, JOLLY, and STEWART, Circuit Judges.

KING, Circuit Judge:

     This appeal involves the question whether a bankruptcy

court, upon motion of a Chapter 11 debtor,     may equitably

subordinate the claim of a creditor who exercised a contractual

right to recoup from the debtor sums it became obligated to pay

to other creditors who had filed liens against the recouping

creditor's property.   The debtor contended that the exercise of

the right of recoupment constituted an inequitable exercise of
control over the debtor, forcing the debtor into bankruptcy, all

to the detriment of other creditors.   The bankruptcy court held

that the exercise of a contractual right of recoupment did not

amount to a type of inequitable conduct that could form the basis

for equitable subordination and dismissed the debtor's claim for

equitable subordination under Rule 12(b)(6).   The district court

affirmed.   We also affirm.

                I.   FACTUAL AND PROCEDURAL HISTORY

     On March 13, 1992, United States Abatement Corporation

("USA") filed a voluntary petition for bankruptcy under Chapter

11 of the Bankruptcy Code.    On April 20, 1992, Mobil Exploration

and Producing U.S., Inc. ("Mobil") filed a timely unsecured

nonpriority Proof of Claim in the amount of $365,000, asserting

that Mobil had a contractual right to indemnification from USA

for amounts expended to pay off the liens of subcontractors.1

These liens had attached to Mobil's property when USA failed to

pay subcontractors who provided services pursuant to two

contracts between USA and Mobil calling for USA to sandblast and

paint certain structures belonging to Mobil located on the Outer

Continental Shelf.

     1
       Our opinion in a related appeal, also decided today,
describes in greater detail the relationship between USA and
Mobil and the circumstances that led to this litigation. See
United States Abatement Corp. v. Mobil Exploration & Producing
U.S., Inc. (In re United States Abatement Corp.), No. 93-3582,
___ F.3d ___, slip op. at _____ (5th Cir. 1994).

                                  2
     On June 15, 1992, USA filed a complaint seeking equitable

subordination of Mobil's claim.    Mobil responded by filing a

motion pursuant to Rule 12(b)(6) of the Federal Rules of Civil

Procedure asserting that USA had failed to state a claim upon

which relief could be granted.    USA filed an amended complaint on

November 6, 1992, in which it set forth additional facts in

support of its equitable subordination claim.    Specifically, USA

contends that the facts set forth in its amended complaint

establish that Mobil exercised control over the financial affairs

of USA to such an extent that USA's other creditors were harmed

thereby.

     On November 13, 1993, the bankruptcy court granted Mobil's

motion to dismiss USA's equitable subordination claim.    On August

4, 1993, the district court entered judgment affirming the

bankruptcy court's decision.     In re U.S. Abatement Corp., 157

B.R. 590 (E.D. La. 1993).   USA filed a timely appeal to this

court, asserting two points of error:    (1) the bankruptcy court

erred in addressing USA's equitable subordination action prior to

determining whether Mobil held a valid claim against USA's

estate; and (2) the bankruptcy and district courts erred in

concluding that USA had failed to state a claim justifying

equitable subordination.

                     II.    STANDARD OF REVIEW

     A dismissal for failure to state a claim is disfavored in

the law and justified only if it appears beyond doubt that the

                                  3
plaintiff can prove no set of facts in support of his claim that

would entitle him to relief.      Conley v. Gibson, 355 U.S. 41, 45-

46 (1957); Carney v. Resolution Trust Corp., 19 F.3d 950, 954

(5th Cir. 1994); Mahone v. Addicks Util. Dist. of Harris County,

836 F.2d 921, 926 (5th Cir. 1988).      In evaluating the propriety

of a dismissal, we accept the plaintiff's well-pleaded facts as

true.    Norman v. Apache Corp., 19 F.3d 1017, 1021 (5th Cir.

1994); Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.

1993).    Furthermore, the question of whether a creditor's conduct

is so egregious as to require the remedy of equitable

subordination is a question of law, over which an appellate court

may exercise plenary review.      Smith v. Associates Commercial

Corp. (In re Clark Pipe & Supply Co.), 893 F.2d 693, 699-700 n.5

(5th Cir. 1990).

                           III.    ANALYSIS

     In order properly to assess USA's claim of equitable

subordination, it is helpful to summarize the key provisions of

the two contracts between Mobil and USA.      Both contracts

contained three relevant clauses:       (1) a termination clause; (2)

an indemnification clause; and (3) a retainage clause.      The

termination clause stated, "Company [Mobil] reserves the right to

terminate this contract with or without cause at any time."        The

termination clause also contained a provision for calculating

compensation due to USA should Mobil exercise its right to

terminate the contracts.   Thus, the termination clause on its

                                    4
face permitted Mobil to terminate the contracts for any reason,

yet ensured that USA would be compensated for any work it had

completed up until the time of termination.   The bankruptcy court

in this case concluded that the termination clause was valid

under Louisiana law.   See American Waste and Pollution Control

Co. v. Jefferson Davis Parish Sanitary Landfill Comm'n, 578 So.

2d 541 (La. Ct. App. 1991), cert. denied, 581 So. 2d 694 (La.

1991) (enforcing termination clause on grounds that "[a] written

contract between two parties is the law as to those parties and

the courts are bound to enforce the contract as written.").    USA

does not contest the bankruptcy court's legal conclusion that the

termination clause is fully enforceable as written.

     The two contracts between Mobil and USA also contained an

indemnification clause which read:

     Contractor [USA] further agrees to pay Company [Mobil] for
     damages to its property and to indemnify and hold Company
     harmless against the payment of any and all taxes,
penalties, interest, liens or indebtedness or claims against
     its property, or for work performed, or measured by the work
     performed, growing out of or incident to Contractor's
operations hereunder.

(emphasis added).

     The contracts also contained a retainage clause whereby

Mobil was authorized to withhold thirty percent of money due to

USA as leverage to ensure that USA paid off all subcontractors

who might assert liens against Mobil's property.   The bankruptcy

court concluded that the indemnification clause was unambiguous

and enforceable as written, rejecting USA's argument that the

retainage clause superseded the indemnification clause by placing

                                 5
a "cap" of thirty percent on the amount to which Mobil was

contractually entitled to recoup from USA to clear its property

of subcontractors' liens.   The bankruptcy court reasoned that

while the retainage clause provided Mobil with prophylactic

protection against the formation of liens, the indemnification

clause provided additional protection by explicitly granting

Mobil a right of full indemnification should any subcontractors'

liens actually materialize.   USA does not contest the bankruptcy

court's interpretation of the relationship between the

indemnification and retainage clauses.

     The bankruptcy court concluded that under the terms of the

two contracts between USA and Mobil, Mobil was entitled to recoup

the full amount of all subcontractors' liens paid and owing on

its property against the amounts due to USA under the contracts.

Thus, of the $692,099 owed by Mobil to USA under the contracts,

the bankruptcy court found that Mobil could subtract $607,052.82,

the amount Mobil paid or owed subcontractors who had filed liens

against Mobil's property.   Mobil's total remaining obligation to

USA on the contracts was therefore $85,046.18.2

     USA's first argument on appeal is that the bankruptcy court

erred in deciding the request for equitable subordination prior

to deciding whether Mobil had a valid claim against USA's estate.

In other words, USA believes the bankruptcy court "put the cart

before the horse" by deciding that there was no reason to invoke

     2
       The bankruptcy court noted that because USA had assigned
all of its accounts receivable to Delta Bank, the $85,046.18 owed
to USA actually belonged to Delta.

                                 6
equitable subordination of Mobil's claim because the bankruptcy

court never determined that Mobil had a valid claim against USA's

estate in the first place.   USA asserts that the bankruptcy

court's order of addressing these issues deprived it of a full

panoply of litigation choices.   Specifically, USA contends that

if the bankruptcy court first had addressed the issue of whether

Mobil had a valid claim, USA would have been in a better position

to evaluate the propriety of pursuing its equitable subordination

claim.   We find this contention to be without merit.

     We initially note that the bankruptcy court's determination

as to what order it should address motions before it is a matter

best left to its sound discretion.     Landis v. North Am. Co., 299

U.S. 248, 254 (1936) (acknowledging "the power inherent in every

court to control the disposition of the causes on its docket with

economy of time and effort for itself, for counsel, and for the

litigants.   How this can best be done calls for the exercise of

judgment . . . .").   There is no requirement in the Bankruptcy

Code, Bankruptcy Rules or case law that a bankruptcy court

address the merits of a pending claim prior to disposing of a

motion for equitable subordination.3    Thus, an appellate court

     3
        In fact, the resolution of a claim for equitable
subordination -- particularly when the amount owed by the debtor
could represent a material portion of the debtor's liabilities --
may foster the expeditious and orderly structuring of the
reorganization plan. The same can often be said for a claim that
related debtors should be substantively consolidated. It may be
desirable for the bankruptcy court to resolve such claims as
early as possible.
     We also note that the speedy resolution of USA's equitable
subordination claim was not, and was not alleged to be, part of a
subterfuge to avoid the mechanisms and protections of Chapter 11;

                                 7
should be loathe to substitute its judgment for the bankruptcy

court regarding such matters of docket management absent an abuse

of discretion.   In re Stone, 986 F.2d 898, 903 n.3 (5th   Cir.

1993) (noting that decisions regarding docket management are

subject to an abuse of discretion standard); accord Penn v. Iowa

State Bd. of Regents, 999 F.2d 305, 307 (8th Cir. 1993)

("District courts have the duty and power to manage their dockets

and we will not interfere in the absence of an abuse of

discretion.").

     Other than its allegation that the bankruptcy court's

prioritization of these issues deprived it of maximum litigation

choice, USA offers no facts to indicate an abuse of discretion.

It is important to note that the bankruptcy court's chosen order

of resolving these claims did not deprive USA of the opportunity

to litigate the question of whether Mobil held a valid claim;

rather, the validity of Mobil's claim was simply resolved later

than USA would have preferred.   USA also fails to recognize that

the swift disposition of the equitable subordination claim was at

least partially dictated by USA's own act of filing a motion for

equitable subordination before the bankruptcy court had

determined whether Mobil held a valid claim.   Thus, it appears

that USA is asking us to characterize the bankruptcy court's

decision on the equitable subordination motion as an abuse of

discretion because it was arrived at too expeditiously.    We

thus, the so-called Braniff doctrine is inapposite. See Pension
Benefit Guaranty Corp. v. Braniff Airways, Inc. (In re Braniff
Airways, Inc.), 700 F.2d 935, 940 (5th Cir. 1983).

                                 8
decline the invitation to condemn lower courts for promptly

resolving the issues before them.

     The second issue raised in this appeal is whether the

bankruptcy and district courts erred in determining that USA's

request for equitable subordination of Mobil's claim lacked

merit.    After a careful review of the record, we agree with the

lower courts that there is no basis for equitably subordinating

Mobil's claim.

     The law of equitable subordination in this Circuit is well

established.    The judicially-created doctrine of equitable

subordination is presently codified at 11 U.S.C. § 510(c).4

While § 510(c) does not specify the circumstances under which

equitable subordination may be imposed, the legislative history

of that section reveals that Congress intended it to encompass

existing common law principles.       See S. Rep. No. 989, 95th Cong.,

2d Sess., at 74, reprinted in 1978 U.S.C.C.A.N. 5787; accord

Fabricators, Inc. v. Technical Fabricators, Inc. (In re

Fabricators, Inc.), 926 F.2d. 1458, 1464 (5th Cir. 1991); Holt v.

FDIC (In re CTS Truss, Inc.), 868 F.2d 146, 148 (5th Cir. 1989).

     Equitable subordination is a remedial, not penal, measure

which is used only sparingly.     In re Fabricators, Inc., 926 F.2d

     4
         Section 510(c) provides in relevant part:

     (c) . . . after notice and a hearing, the court may--
          (1) under principles of equitable subordination,
subordinate for purposes of distribution all or part of an
allowed claim to all or part of another allowed claim . . . .

11 U.S.C. § 510(c).

                                  9
at 1464.   This court has established a three-prong test to

identify those situations in which equitable subordination is

permitted: (1) the claimant must have engaged in some type of

inequitable conduct; (2) the conduct must have resulted in injury

to the creditors or conferred an unfair advantage on the

claimant; and (3) the invocation of equitable subordination must

not be inconsistent with the provisions of the Bankruptcy Code.

In Re Fabricators, Inc., 926 F.2d at 1464-65; Smith v. Associates

Commercial Corp. (In re Clark Pipe & Supply Co.), 893 F.2d 693,

699 (5th Cir. 1990); Benjamin v. Diamond (In re Mobile Steel

Co.), 563 F.2d 692, 700 (5th Cir. 1977).

     While our three-pronged test appears to be quite broad, we

have largely confined equitable subordination to three general

paradigms:   (1) when a fiduciary of the debtor misuses his

position to the disadvantage of other creditors; (2) when a third

party controls the debtor to the disadvantage of other creditors;

and (3) when a third party actually defrauds other creditors.

Holt v. FDIC (In re CTS Truss, Inc.), 868 F.2d 146, 148-49 (5th

Cir. 1989) (citing cases).   The first paradigm is inapplicable in

this case because USA has offered no facts to establish that

Mobil had a fiduciary obligation to USA.   Mobil was merely in a

contractual relationship with USA, not a relationship of trust

which would give rise to mutual fiduciary duties.5   The third

     5
       USA's only allegation of the existence of a fiduciary
relationship appears in its brief, which asserts that because
Mobil was a recipient of services who failed to pay for services
rendered, it "can in fact, or should in fact, become a fiduciary
to USA because of its control and domination over the debtor."

                                10
paradigm is inapplicable because USA has not alleged that Mobil

defrauded USA or its creditors.    Thus, USA's equitable

subordination claim rests upon the second paradigm; specifically,

USA asserts that Mobil controlled USA to the detriment of other

creditors.

     USA's only factual basis for asserting that Mobil controlled

USA to the detriment of other creditors is that Mobil refused to

pay certain sums due under the two contracts.     USA further

asserts that the sums due were "not under a bona fide dispute"

because USA had substantially completed certain structures, Mobil

had no complaints about the quality of the work performed, and

the contracts called for structure-by-structure payment.      Because

the sums due under the contracts with Mobil represented all (or

virtually all) of the income flow of USA, USA contends that

Mobil's non-payment resulted in detriment to other creditors.

More specifically, USA contends that Mobil's non-payment

effectively forced USA to pay off certain subcontractors who had

placed liens on Mobil's property to the detriment of Delta Bank,

Thus, USA appears to assert that the mere existence of control or
domination over the debtor gives rise to a fiduciary
relationship. Such a theory would not only make the control
paradigm superfluous, but would also turn the law of fiduciary
relationships on its head. It is hornbook law that a fiduciary
relationship arises when one party has a duty to act for the
benefit of the other party as to matters within the scope of the
relationship. See AUSTIN WAKEMAN SCOTT & WILLIAM FRANKLIN FRATCHER, 1
THE LAW OF TRUSTS § 2.5, at 43 (4th ed. 1987); RESTATEMENT (SECOND) OF
AGENCY § 13, cmt. a (1958). Classic examples of fiduciary
relationships are agent/principal, attorney/client, and
guardian/ward. As a mere party to a contract for services, Mobil
was not in a fiduciary relationship with USA because Mobil had no
duty to act for the benefit of USA.

                                  11
to whom USA had assigned all its receivables, and to the

detriment of other unsecured creditors who were not in a position

to place liens on Mobil's property.

     We know of no cases (and USA cites none in its brief) in

which the exercise by one party to a contract of a contractual

right to withhold payment occasioned by the breach by the other

contracting party of that contract has been considered the type

of inequitable "control" which would justify equitable

subordination.   Indeed, in an analogous case, Smith v. Associates

Commercial Corp. (In re Clark Pipe & Supply Co.), 893 F.2d 693

(5th Cir. 1990), we held that a lender's reduction of available

funds to a borrower (a subsequent Chapter 7 debtor) in a

revolving line of credit was not the type of unconscionable

conduct which would constitute "control" sufficient to invoke

equitable subordination.   We reached this conclusion based

primarily upon the fact that the contract between the lender and

borrower expressly permitted the lender to reduce available funds

according to the level of the borrower's accounts receivable.

Because the lender had merely exercised his contractual right to

reduce the available funds when the borrower's accounts

receivable declined, there was not, absent more, any inequitable

conduct to invoke equitable subordination.   As we explained:

          Associates' control over Clark's finances, admittedly
     powerful and ultimately severe, was based solely on the
     exercise of powers found in the loan agreement. Associates'
     close watch over Clark's affairs does not, by itself,
however, amount to such control as would justify equitable
subordination. . . . Although the terms of the agreement did
     give Associates potent leverage over Clark, that agreement
     did not give Associates total control over Clark's

                                12
activities. At all material times Clark had the power to          act
autonomously and, if it chose, to disregard the advice            of
Associates; for example, Clark was free to shut its doors         at
any time it chose to do so and to file for bankruptcy.

In re Clark Pipe & Supply Co., 893 F.2d at 702.

      In this case, Mobil had the contractual right to recoup from

the amount due to USA the amount of any liens placed on Mobil's

property by USA's subcontractors.     Because USA disputed this

recoupment right, there was a bona fide dispute among the parties

as to what amount (if any) Mobil owed USA under the contracts.

In order to resolve this dispute, Mobil filed a declaratory

judgment action and withheld payment to USA pending resolution of

this matter by the courts.   While Mobil's withholding of payment

certainly created economic hardship for USA, the act of

withholding was made pursuant to Mobil's contractual right to do

so.   Thus, as in Clark Pipe, Mobil's actions created economic

leverage to force USA to pay off the subcontractors who had filed

liens on Mobil's property prior to paying off other creditors.

Yet this economic leverage, asserted by Mobil pursuant to the

terms of the contracts, did not give Mobil inequitable control

over USA.   Because the behavior of Mobil which USA complains of

would not support a finding of inequitable conduct by Mobil, we

agree that dismissal of USA's equitable subordination claim for

failure to state a claim was proper.

                          IV.   CONCLUSION

                                 13
     For the foregoing reasons, we AFFIRM the judgment of the

district court.

                               14