IN RE CHAPTER 7, MERRY-GO-ROUND ENTERPRISES, (Bankr.D.Md. 1999)

E. Stephen Derby, Judge

Before the court are motions by four former executives of Merry-Go-Round Enterprises, Inc. ("MGRE") seeking allowance of their compensation claims as administrative expenses. MGRE is the Debtor, and it initiated this case by filing a voluntary petition under Chapter 11 that was eventually converted to Chapter 7. The Executives' claims arise from deferred compensation agreements between the Executives and MGRE that were entered into prepetition.

Two issues are raised by the motions. First, should the claims be categorized as administrative expenses or as prepetition claims; and second, how should the claims be quantified. After an evidentiary hearing, and for the reasons discussed below, the court concludes that the claims are not administrative expenses, but rather prepetition claims, and that the claims must be valued without considering the risk of payment.

Facts

Prior to the petition date, Kenneth Rodriguez, Paul D. Levine, George E. Kucin, and Marvin S. Rice (the "Executives", and individually "Executive"), all former executives of MGRE, entered into separate deferred compensation agreements with the MGRE. Each Deferred Compensation Agreement provided that the Executive would receive $100,000 per year for life commencing at age 65, adjusted annually thereafter based on the Consumer Price Index. Further, each agreement provided that the Executive's interest would vest fully if he worked for MGRE for seven years after the date of the agreement. Prior to MGRE's petition date, each Executive's interest in his deferred compensation had fully vested. None of the Executives, however, was eligible to receive his deferred compensation at the time MGRE filed its bankruptcy petition.

Each Executive filed a motion for the allowance of his claim as a Chapter 11 administrative expense pursuant to 11 U.S.C. § 503(b) and 507(a)(1). Each claim, as amended, is for the actuarially determined present value of the total to become due to the Executive under his Deferred Compensation Agreement, determined as of the approximate date this case was converted from Chapter 11 to Chapter 7.

To establish the Chapter 11 administrative status of their respective claims, all Executives rely on a preconversion order entered on April 11, 1994 authorizing the payment of certain prepetition employee benefits. See Dkt. P. 434. The last two ordered paragraphs provide:

FURTHER ORDERED, the Debtor shall be permitted to make any unpaid pre-petition contributions to its Executive Deferred Compensation Plan, and it is

FURTHER ORDERED, that the Debtors shall be permitted to honor and maintain the supplemental retirement agreements described in the Motion. Id.; Movants' Exh. 4.

Messrs. Rice and Rodriguez allege additional grounds for administrative claim status. Mr. Rice's claim includes the third year of his severance pay and medical insurance reimbursement. In support of this allegation Rice again relies on another paragraph in the April 11, 1994 order. The pertinent ordered paragraph states:

FURTHER ORDERED, that the Debtors shall be permitted to honor and make all payments and to otherwise honor all obligations in connection with the Severance Agreements to Messrs. Lucas, Wood, and Rice, as more specifically described in the Amended Motion. . . . Id. (Emphasis supplied). Further, Mr. Rice had left MGRE's employ prepetition and on January 26, 1996, preconversion, and he executed an age 60 early retirement agreement. Movants' Exhs. 11, 12. Under that agreement, Mr. Rice was to begin receiving his annual benefit of $100,000 from his Deferred Compensation Agreement at age 60, and he waived subsequent adjustments to increase his benefits. Mr. Rodriguez relies on an order entered August 31, 1995, as an additional basis for his claim. The August 31, 1995 order approved, inter alia, for the terms of Rodriguez' severance, as follows:

5. MGRE is authorized to provide severance benefits to Kenneth Rodriguez upon the following terms:

. . . .

b. Payment of severance benefits for 12 months plus one week for each year of post-petition service shall constitute administrative expenses of MGRE. Mr. Rodriguez shall have an allowed general unsecured prepetition claim in an amount equal to one week of salary for each year of employment prior to MGRE's petition date.

c. During the severance period, Mr. Rodriguez shall be entitled to continue to receive all existing employee benefits. Mr. Rodriguez shall also be entitled to receive his supplemental retirement benefits in which he is fully vested.

. . . .

e. Payment for unused vacation time totaling 80 hours shall be allocated to the period, either pre-petition or post-petition, during which such time was earned. Payments for vacation time allocated to the post-petition period shall be paid as an administrative expense. Mr. Rodriguez shall have an allowed general unsecured claim in the amount of vacation time allocated to the pre-petition period.

6. All obligations of MGRE to . . . Mr. Rodriguez described in paragraph . . . 5 above shall be binding upon MGRE and its estate, and all successors in interest thereto. Except as provided in . . . paragraphs 5.b and 5.e with respect to Mr. Rodriguez, payments due to . . . Mr. Rodriguez under this Order shall be treated as administrative expenses under 11 U.S.C. § 503(b) and shall be entitled to the priority granted by 11 U.S.C. § 507(a)(1).

Dkt. P. 4063, pp. 4-6; Movants' Exh. 9, pp. 4 — 6.

Because each agreement was entered into prepetition, and because each Executive was fully vested prepetition, the Trustee argues that each Executive's claim is a prepetition unsecured claim. In further support of her position, the Trustee emphasizes that as of the Chapter 11 petition date, none of the Executives was eligible to receive deferred compensation because he had not reached age 65.

The Trustee challenges the Executives' interpretation of the April 11, 1994 order. She denies it requires that the Executives' deferred compensation benefits be treated as Chapter 11 administrative expenses. Citing Stewart Foods, Inc. v. Broecker (In re Stewart Foods, Inc.), 64 F.3d 141 (4th Cir. 1995), the Trustee argues that because the agreements were entered into prepetition, and because all the Executives' benefits were fully vested prepetition, the executives have general unsecured claims. The court agrees.

Discussion

A. Categorization of Claims

The Executives seek to have their claims allowed as Chapter 11 administrative expenses under 11 U.S.C. § 503(b). Chapter 11 administrative expenses have priority over other unsecured claims, except Chapter 7 administrative expenses. Id. at §§ 507(a)(1), 726(a)(1), and 726(b). Allowable administrative expenses include, "the actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case. . . ." 11 U.S.C. § 503(b)(1)(A). To qualify his deferred compensation claim for treatment as an administrative expense, an Executive must show (1) that his claim arose out of a postpetition transaction with the debtor-in-possession and (2) that the consideration supporting the claim was beneficial to the debtor-in-possession in the operation of its business. See In re Merry-Go-Round Enters., Inc., 180 F.3d 149, 157 (4th Cir. 1999) ("Cutler Ridge").

In Cutler Ridge the United States Court of Appeals for the Fourth Circuit considered a lease that MGRE had entered into postpetition, but which the Trustee breached by rejecting it after the case was converted to Chapter 7. In concluding that the lease rejection damages were Chapter 11 administrative expenses, the court examined each of the elements described above in turn. See id. As to the first, the court stated: "The test to determine actual expense is whether the claim arose out of a post-petition transaction between [the claimant] and MGRE." Cutler Ridge, 180 F.3d at 157. The agreements between MGRE and the Executives were entered into prepetition. Therefore, to be a postpetition transaction the court must find that the deferred compensation agreements were executory contracts that were assumed by MGRE.

The Fourth Circuit has stated that an executory contract is one in which:

the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other.

Gloria Mfg. Corp. v. International Ladies' Garment Workers' Union, 734 F.2d 1020, 1022 (4th Cir. 1984 (quoting Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn.L.Rev. 439, 450-62 (1973)).

The case of Stewart Foods, Inc. v. Broecker, 64 F.3d 141 (4th Cir. 1995), involved a situation that is similar to this matter. In Stewart Foods, the company's president entered into an agreement with the company that he would be paid deferred compensation for ten years after his retirement. After he retired, the company filed for bankruptcy. In holding that the president's claim was a prepetition claim, the court stated that "regardless of the nature of the contract, if at the time of the bankruptcy filing the debtor has an obligation under the contract to pay money to the non-debtor party, that obligation is handled as a pre-petition claim in the bankruptcy proceedings." Id. at 145. The Fourth Circuit found that a retirement agreement executed prepetition, and stipulated by the parties to be non-executory, created a claim against the bankruptcy estate and was not a continuing postpetition obligation. The court further noted that the parties' stipulation about the nature of the contract was accurate because the former owner and founder "had already retired and owed no further employment responsibilities to Stewart Foods." Id. at 146.

In the instant case, each Executive was vested in his deferred compensation prepetition. Once vested, the Executive owed no further performance to MGRE in order to receive the deferred compensation payments that had been earned prepetition. Therefore, the contract was non-executory at the time of the petition. Because the Executives were fully vested prior to the petition, their postpetition employment with the Debtor did not entitle them to have these claims treated as an administrative expense. None of them owed a further duty to the Debtor at the time of the petition in order to receive his deferred compensation at 65. See Stewart Foods, 64 F.3d at 146. The deferred benefits that the Debtor owed to each of the Executives was a prepetition obligation of the Debtor, and the fact that the payments were due after the bankruptcy filing does not alter the conclusion that they are prepetition obligations. See id.

The Executives argue that the April 11, 1994 order implicitly elevated the Executives' prepetition deferred compensation agreements to postpetition administrative expenses. However, the April 11, 1994 order only permitted the Debtors to maintain the status quo; it granted no express, or implied, authority to assume or reject a contract. The order did not address the allowance of prepetition vested benefits as administrative expenses, and it did not make any findings that satisfy the "actual and necessary" administrative expense test. See 11 U.S.C. § 503(b). Therefore, the Executives have not shown that the deferred compensation agreements were postpetition transactions.

Further, Mr. Rice's amendment to his deferred compensation agreement does not elevate the status of his claim to an administrative expense. Although the agreement was executed postpetition, Mr. Rice has not shown that the agreement received court approval or that court approval was unnecessary.

In any event, the amendment is not a new agreement between MGRE and Mr. Rice; it is merely an amendment to the original Deferred Compensation Agreement. Further, and more importantly, it does not change the fact that Mr. Rice was fully vested prepetition. Therefore, Mr. Rice's additional grounds do not alter the conclusion that his claim is a prepetition obligation of MGRE, and not an administrative expense.

Mr. Rice has also included in his administrative claim $75,000 "Severance pay for third year" and $2,745.84 "Medical insurance reimbursement." The Trustee has not directed her objection to the specifics of this claim; rather she has focused on the deferred compensation claim. Fed.R.Bankr.P. 3001(f) provides that "[a] proof of claim executed and filed in accordance with these rules shall constitute prima facie evidence of the validity and amount of the claim." Since the Trustee has not countered the presumption embodied in this rule upholding Mr. Rice's claim as to these two elements, this portion of his claim stands deemed allowed, and it will not be discussed further. See 11 U.S.C. § 502(a).

As for Mr. Rodriguez' claim for deferred compensation as an administrative expense, the language of the August 31, 1995 order approving his severance provides that "payments due to . . . Mr. Rodriguez under this Order shall be treated as administrative expenses. . . ." Movants' Exh. 9 at 6 6. The payments due under the Order were severance payments. Id. at 6 5. Payments of deferred compensation were not provided for in the order, albeit there is an acknowledgment in the second sentence of paragraph 5(c) that "Mr. Rodriguez shall also be entitled to receive his supplemental retirement benefits in which he is fully vested." Id. The Trustee does not question Mr. Rodriguez' entitlement. This sentence falls far short of expressly granting administrative status to claims for benefits vested prepetition under the unmentioned Deferred Compensation Agreement. This sentence is to be contrasted in context to the prior paragraph 5(b) that expressly stated that severance benefits described therein "shall constitute administrative expenses of MGRE." Id. Mr. Rodriguez did not explain the basis for distinguishing his claim for deferred compensation from those of the other Executives, or why the order did something other than to preserve his rights under his prepetition deferred compensation agreement.

Further, to interpret the Rodriguez order as Mr. Rodriguez argues would be inconsistent with the court's oral ruling at the conclusion of the January 17, 1995 hearing. At the conclusion of that hearing the court ruled on items that would and would not be allowed in Mr. Rodriguez' severance package. See Trustee's Supplemental Memorandum, Dkt. P. 6780, Exhibit 2, Transcript pp. 198-201.

The January 17, 1995 hearing was held to determine what benefits would be included, inter alia, in Mr. Rodriguez' severance package.

In its oral ruling the court only granted priority as an administrative expense to claims that Mr. Rodriguez would have been entitled to receive under the Bankruptcy Code. See id. For example, Mr. Rodriguez' accrued vacation time was to be allocated so that any time accrued prepetition would be considered a prepetition claim and any vacation time accruing postpetition would be considered a postpetition claim. See id. at 198-99. Further, additional severance pay of one week for every year of service to the Debtor was to be allocated based on when the services were performed. See id. at 199.

When the court discussed Mr. Rodriguez' benefits, it stated: "[w]ith respect to benefits to continue during the severance period, that would appear to be consistent and reasonable as long as that's what we're talking about, namely, during the severance period." Id. at 199-200. This is far from entitling Mr. Rodriguez to treat his deferred compensation as an administrative claim. The express effort by the court in its oral rulings was to allocate Mr. Rodriguez' benefit claims between pre- and post-petition periods based on when they accrued, this effort rebuffs Mr. Rodriguez' present argument that the court intended to grant postpetition administrative status to his deferred compensation claims that had vested prepetition. It also belies the supposition that the court would have granted administrative status to such a claim without specifically saying so in clear language, as it had done elsewhere in the order. Therefore, Mr. Rodriguez' deferred compensation claim will have the same prepetition status as the other Executives' claims.

Because the Executives have not shown that there was a postpetition transaction between the Executives and MGRE, they have not shown that the debt was an actual expense of the estate. Further, because they cannot show that there was an actual expense to the estate, the Executives cannot show that their claims are administrative expenses. See 11 U.S.C. § 503(b)(1)(A). Consequently, the Executives deferred compensation agreement claims are prepetition claims.

B. Amount of the Claims

Regardless whether the claims are prepetition or postpetition, the court must decide what factors to use when assigning a value to the claims. The Executives' expert was Teresa M. Reider, ASA, EA, a pension actuary with Buck Consultants. She testified that the present value of each Executive's compensation benefit should be computed in accordance with standard actuarial practices for pensions using 1983 Group Annuity Mortality (50% male/50% female) tables, assuming a 3% CPI increase, and utilizing the 30 year U.S. Treasury security interest rate for the month as of which the calculation is made. The three percent (3%) cost of living adjustment, according to Ms. Reider, was less than the average cost of living over the past ten years. Since Mr. Rice elected to receive his deferred compensation at age sixty in exchange for waiving his cost of living adjustments, no cost of living adjustment is used to calculate his claim. Ms. Reider testified that a 30-year Treasury rate is the customary rate used by actuaries when computing present value in similar situations. Based on these assumptions, Ms. Reider developed present value calculations for the deferred compensation claims of each Executive as of March 1, 1996, the conversion date, and April 1, 1994, the approximate petition date. Movants' Exhs. 13, 14.

The Trustee's expert was William Kerr, an economist with Penta Advisory Services, LLC. He developed present values of the future income stream for each Executive, but he utilized different factors in his models. For example, he used the U.S. Department of Health and Human Services life expectancies tables for 1995. By far, however, the factor that produced the greatest disparity in result from the present values of Ms. Reider was the discount rate. Mr. Kerr rejected use of the 30 year U.S. Treasury rate because it was a risk free rate. He instead referred to the lowest quality corporate bond rate, and utilized an S P Class B bond market rate. Mr. Kerr developed a discount rate for each Executive's calculations that was in excess of 10% in order to take risk into account. The risk was that payment of the deferred compensation promised by MGRE would not occur. In Mr. Kerr's opinion, because the deferred compensation plans were unfunded and unqualified, the present value of MGRE's promise of future payment should be calculated based on a high risk bond and not on a treasury security.

A claim is 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. . . ." 11 U.S.C. § 101(5)(A). All parties recognize that a claim for future payments must be reduced to its present value. See, e.g., 22 Am. Jur. 2d Damages § 678. Consequently, the Executives' claims for payment of deferred compensation must be determined at their present values.

The fact that Debtor's promise was not as safe as a treasury bill does not change the fact that once each Executive reached the age of sixty-five, he had a claim for $100,000 per year adjusted for cost of living expenses for fifteen years or until death. The amounts of the Executives' claims do not include a discount based on the risk that the compensation will not be paid. Mr. Kerr was testifying to the value of the claims and not to the present amount of the claims. He factored risk into the present value of the claims, and he did not limit his consideration to the time value of the claims. Because the opinion of the Mr. Kerr was based on a faulty premise, it will not be accepted; and the court will utilize the opinion of Ms. Reider, which is based on customary, actuarial assumptions for valuing pensions, to fix the amounts of the Executives' deferred compensation claims.

Because the Executives' deferred compensation claims are prepetition claims, the present value of each should be determined as of the petition date, namely, January 11, 1994. The Executives' various arguments that later dates should be used are flawed, because use of a later date would have the effect of paying interest on an unsecured claim, which is not permitted. 11 U.S.C. § 502(b)(2). The closest date for which Ms. Reider made a calculation is as of April 1, 1994, and the court will accept these figures as fixing the amounts of each Executive's deferred compensation claim. Movants' Exh. 14.

Conclusions

The Executives' motions seeking allowance of their deferred compensation claims as administrative expenses will be denied, because their deferred compensation benefits were fully vested as of MGRE's petition date. Further, no postpetition action, by either the court or MGRE, had the effect of creating a postpetition contract between MGRE and the Executives. The deferred compensation claims of the Executives are fixed in the amounts set forth in Movants' Exhibit 14.

Therefore, upon consideration of the Executives' motion for payment of administrative expenses, the Trustee's response thereto, after an evidentiary hearing, and for the reasons stated above, it is this _____ day of October, 1999, by the United States Bankruptcy Court for the District of Maryland,

ORDERED, that the respective motions for allowance of administrative expenses are DENIED as to deferred compensation; and it is further

ORDERED and DECLARED, that the Executives' claims for deferred compensation are prepetition claims; and it is further

ORDERED and DECLARED, that the amount of each Executive's prepetition claim for deferred compensation is the present value of the claims as of the date MGRE's bankruptcy petition was filed on January 11, 1994; and it is further

ORDERED, that the amount of each Executive's prepetition unsecured deferred compensation claim is as follows:

Kenneth Rodriguez — $326,197

Paul D. Levine — $283,481

George E. Kucin — $304,090

Marvin S. Rice — $981,422

cc: Allan P. Hillman, Esquire Thomas M. Wood, IV, Esquire Neuberger, Quinn, Gielen, Rubin Gibber One South Street, 27th Floor Baltimore, MD 21202-3201

Lawrence D. Coppel, Esquire Gordon, Feinblatt, Rothman, Hoffberger Hollander 233 E. Redwood Street Baltimore, MD 21202

Office of the U.S. Trustee 300 W. Pratt Street, Suite 350 Baltimore, MD 21201