Reading Co. v. Brown
1968 U.S. LEXIS 2986, 20 L. Ed. 2d 751, 88 S. Ct. 1759 (1968)
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Rule of Law:
Damages resulting from the negligence of a receiver acting within the scope of his authority during a Chapter XI arrangement are considered "actual and necessary costs" of administration, entitling the claims to first-priority payment under § 64a(1) of the Bankruptcy Act.
Facts:
- I. J. Knight Realty Corporation's principal asset was an eight-story industrial building it leased to others.
- Knight Realty filed a petition for a Chapter XI bankruptcy arrangement.
- A court-appointed receiver, Francis Shunk Brown, was authorized to continue operating Knight Realty's business.
- While the business was under the receiver's control, a fire, assumed to be caused by the negligence of the receiver or his employee, started in the building.
- The fire completely destroyed Knight Realty's building.
- The fire spread to adjacent premises, destroying property owned by Reading Company and 146 other claimants.
Procedural Posture:
- I. J. Knight Realty Corporation filed a petition for an arrangement under Chapter XI of the Bankruptcy Act in the District Court.
- After its property was destroyed by fire, Reading Company filed a claim in the arrangement for administrative expenses.
- Knight Realty was subsequently adjudicated a bankrupt, and the receiver was elected trustee.
- The trustee moved to expunge Reading Company's claim on the ground that it was not for an expense of administration.
- The bankruptcy referee disallowed the claim for administration expenses.
- On review, the District Court upheld the referee's decision.
- The Court of Appeals for the Third Circuit, sitting en banc, affirmed the judgment of the District Court.
- The United States Supreme Court granted certiorari to review the decision.
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Issue:
Does a tort claim arising from the negligence of a receiver administering a debtor's estate during a Chapter XI arrangement qualify as an "actual and necessary" cost of administration entitled to first priority payment under § 64a(1) of the Bankruptcy Act?
Opinions:
Majority - Mr. Justice Harlan
Yes. A tort claim arising from the negligence of a receiver during a Chapter XI arrangement qualifies as an "actual and necessary" administrative expense. The court reasoned that one of the key objectives of the Bankruptcy Act is fairness to all persons with claims against the insolvent entity. The petitioner, Reading Company, did not simply suffer an injury from an insolvent business; it had an insolvent business's operation 'thrust upon it by operation of law' for the benefit of pre-existing creditors. It would be inconsistent with principles of fairness and respondeat superior to force an innocent tort victim to bear the costs of a failed rehabilitation attempt, while the creditors who stood to benefit are prioritized. Treating such torts as administrative expenses also encourages receivers to obtain adequate insurance, the premiums for which are indisputably administrative costs.
Dissenting - Mr. Chief Justice Warren
No. A tort claim arising from the negligence of a receiver should not qualify as a first-priority administrative expense. The central theme of the Bankruptcy Act is 'equality of distribution,' and the majority's holding violates this principle by giving a select class of tort claimants preference over general creditors, wage claimants, and government tax claims. The dissent argues that administrative costs should be limited to those truly necessary to facilitate a smooth arrangement, such as paying suppliers and employees, to encourage third parties to deal with the business. Elevating massive, unpredictable tort claims to first priority will discourage creditors from agreeing to rehabilitative arrangements, forcing more businesses into liquidation and frustrating the purpose of Chapter XI.
Analysis:
This decision significantly broadens the definition of "actual and necessary costs" of administration in bankruptcy. It establishes that the costs of operating a business during a reorganization include the costs of its torts, not just its transactional expenses. The ruling prioritizes fairness to innocent third parties injured during the bankruptcy process over the claims of pre-existing creditors. This shifts the risk of continued operations during an arrangement from potential new victims onto the existing creditors who stand to benefit from a successful rehabilitation.
