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In re Photo Promotion Associates Inc.

decided: August 1, 1989.


C.P.Q. Colorchrome appeals the December 5, 1988 decision and order of the United States District Court for the Southern District of New York (Goettel, J.), that affirmed the July 1, 1988 decision of the Bankruptcy Court (Schwartzberg, B.J.). Affirmed.

Newman, Cardamone and Winter, Circuit Judges

Author: Cardamone

CARDAMONE, Circuit Judge

On this appeal from a December 5, 1988 order of the United States District Court for the Southern District of New York (Goettel, J.), affirming decisions of the Bankruptcy Court (Schwartzberg, J.) dated July 15 and August 25, 1988, we consider what effect a creditor's entering into a contract with a debtor in possession for their mutual advantage and in disregard of the United States Bankruptcy Code (Code) has on the creditor's status in the bankrupt estate. We must decide whether appellant, as a valid creditor, can be forced to pay back post-petition funds it collected under an unauthorized assignment of the debtor's accounts receivable and whether it can then be relegated to pursuing an administrative claim for the services it clearly rendered -- a claim that would be subordinate to those of other creditors with priority status. To state the question more precisely, we consider the following: Whether a trustee may, pursuant to 11 U.S.C. §§ 549(a) and 550(a) of the Code, compel a Chapter 11 creditor who violates 11 U.S.C. § 364(c) to return to the debtor's estate the $81,296.75 obtained as a consequence of that violation. We hold that the trustee may obtain the return of those monies even though the creditor has a valid administrative claim under § 503(b). Consequently, we affirm.


The facts are largely uncontroverted and may be briefly stated. The debtor in this bankruptcy proceeding is Photo Promotion Associates, Inc. (Photo Promotion or PPA), a New York corporation. Its business consisted of selling family and individual photographs mounted on wooden plaques to department store customers. Appellant CPQ Colorchrome Corp. (CPQ), a division of Coppinger Color Lab, is a Tennessee corporation that develops film and photographs.

After filing for Chapter 11 protection on October 4, 1984 Photo Promotion, in continuing its business as the debtor in possession, needed photographic processing services. During the pendency of the Chapter 11 proceeding, and prior to conversion to a Chapter 7 liquidation proceeding, it entered into an agreement with CPQ on December 20, 1984 to procure the necessary services. In return for the services provided by CPQ, Photo Promotion assigned a portion of its accounts receivable to be paid directly to CPQ by the debtor's customers. This spared CPQ from looking to Photo Promotion for payment, a risk CPQ was unwilling to take given the debtor's precarious finances. The December 20 agreement stated that Photo Promotion "[agreed] to protect the parties to the assignment by placing the name and address of 'CPQ' [rather than Photo Promotion] on the first and each 'C.O.D.' remittance direction slip shipped . . . ."

Further, the parties established a post office box in Monsey, New York under the name "PPA Reorder Department or Division," which was under the control of CPQ. Remittances sent to Photo Promotion there were then forwarded to CPQ for deposit in its Cleveland, Tennessee bank account. In an affidavit, CPQ's Vice President for Marketing explained the payment system: "We ended up designating to be paid directly to [CPQ] an amount of the C.O.D. charges which PPA made to its customers which would equal 150% of our charges to PPA. This was done as a substitute to a C.O.D. delivery to PPA which at that time did not have cash to pay us. We used 150% of our charges under the assumption that as many as 1/3 of the orders would be rejected by the customer because of delay. Any surplus we received would have been turned back to PPA." This arrangement lasted from late 1984 through April, 1985.

On March 13, 1985 the Chapter 11 proceeding was converted to a Chapter 7 liquidation case and a trustee was appointed. Nine months later, the trustee initiated proceedings against CPQ to annul the post office box arrangement and to recoup the funds that CPQ had already obtained. In its counterclaim, CPQ asserted an administrative claim for the photographic processing services it had rendered. On April 30, 1987 the bankruptcy court held that the December 20 agreement violated § 364(c) of the Code, and that CPQ therefore did not have a secured interest in the debtor's accounts receivable. On August 19, 1987 the parties entered a court approved stipulation (the 1987 stipulation) construing the bankruptcy court's earlier decisions; the import of the stipulation -- to be discussed later -- is disputed. Because the April 30 decision rendered CPQ an unsecured creditor, it appealed. A year later, without either affirming or reversing, the district court remanded the case to the bankruptcy court for clarification of CPQ's status and a determination of whether, having failed to satisfy § 364(c), CPQ could "fall back" to state an administrative claim incurred in the ordinary course of business under § 364(a).

Following a hearing, the bankruptcy court on July 1, 1988 rejected the § 364(a) "fall back" argument, but held that because CPQ had rendered post-petition services to preserve the debtor's estate it was entitled to assert an administrative claim under § 503(b)(1)(A), subject to super-priority expenses incurred during the Chapter 7 proceeding. The bankruptcy court further held that before it could assert its § 503(b) claim, CPQ was first required to return to the trustee those monies that it had obtained by means of the post office box arrangement. In addition, the court found that the trustee could challenge the amount of the administrative expenses CPQ claimed by disputing the quality of the services CPQ rendered. By an order entered on December 5, 1988 the district court affirmed the bankruptcy court's decisions and orders. This appeal followed.



We begin by considering those sections of the Bankruptcy Code implicated in this appeal. The provision of the Code that CPQ was found to have violated is 11 U.S.C. § 364(c), which provides: "If the trustee is unable to obtain unsecured credit allowable under section 503(b)(1) of this title as an administrative expense, the court, after notice and a hearing, may authorize the obtaining of [secured/priority] credit or the incurring of debt." Section 503(b)(1)(A) of the Code, under which CPQ subsequently was held to have an administrative claim, makes reimbursable post-petition administrative expenses after notice and a hearing -- claims that represent "the actual, necessary costs and expenses of preserving the estate." The trustee sued CPQ under 11 U.S.C. § 549(a) -- a provision that concerns post-petition transactions -- which states the rule that a trustee "may avoid a transfer of property of the estate -- (1) that occurs after the commencement of the case; and . . . (2)(b) that is not authorized under this title or by the court." That rule is subject to narrow exceptions set forth in § 549(b) and (c) that by their own terms do not apply to this case. Finally, § 550(a) gives the trustee a mechanism for recovering transferred property from the transferee in transactions that were avoided under § 549(a).

Given the esoteric nature of this corner of bankruptcy law, it is helpful to note what is not at issue. CPQ concedes that its transaction was not authorized by § 364(c). The trustee does not cross-appeal from the holding that CPQ may assert an administrative claim under § 503(b), though under the terms of the 1987 stipulation the trustee disputes the amount of that claim. The question before us, therefore, is whether the avoidance and recoupment provisions of §§ 549(a) and 550(a) have application to funds paid out by a debtor -- though ...

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