Safeco Insurance Company Of America v. City of Coffeyville, KS et al

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE WESTERN DISTRICT OF MISSOURI
In re: )
)
)
FARMLAND INDUSTRIES, INC., et al., ) Case No. 02-50557-JWV
) Joint Administration
Debtors. )
)
SAFECO INSURANCE COMPANY OF )
AMERICA, )
)
Plaintiff, )
)
v. ) Adversary No. 03-4066-JWV
)
CITY OF COFFEYVILLE, KANSAS, )
FARMLAND INDUSTRIES, INC., and )
INTRUST BANK, N.A. )
)
Defendants. )
MEMORANDUM OPINION
Safeco Insurance Company of America (“Safeco”) filed a nine-count complaint against the City
of Coffeyville, Kansas (“Coffeyville”), Farmland Industries, Inc. (“Debtor”), and Intrust Bank, N.A.
(“Intrust”) seeking declaratory relief with respect to its potential liability for a $12,000,000 surety
bond it issued on the Debtor’s behalf. The surety bond guaranteed the Debtor’s future performance
under an electrical services agreement (“ESA”) with Coffeyville for the supply of electricity to the
Debtor’s petroleum coke gasification to nitrogen fertilizer facility (“Facility”). To meet its obligation
under the ESA, Coffeyville built a new electrical power substation financed through the sale of bonds,
held by Intrust as the indenture trustee. The gist of Safeco’s complaint is that Coffeyville negotiated
with the purchaser of the Facility, Coffeyville Resources, LLC (“CRLLC”), to have the Debtor reject
the ESA in its bankruptcy proceeding and thereby invoke Safeco’s liability on the surety bond while
at the same time Coffeyville and CRLLC entered into a new electrical service agreement.
Before filing an answer to the complaint, Coffeyville and Intrust filed Fed. R. Civ. P. 12(b)
motion – as incorporated into bankruptcy proceedings by Fed. R. Bankr. P. 7012 – to dismiss Safeco’s
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complaint on the grounds that this Court lacks subject matter jurisdiction over the dispute, and that
Safeco failed to state any claims upon which relief could be granted. Coffeyville also filed a separate
motion requesting that this Court abstain from hearing the dispute. For the reasons stated herein, the
Court will exercise subject matter jurisdiction over the dispute, not enter an order of abstention, and
will deny Coffeyville and Intrust’s Rule 12(b)(6) motion to dismiss Safeco’s complaint.
I. STANDARD OF REVIEW
In reviewing a Rule 12(b)(6) motion to dismiss for failure to state a claim upon which relief
can be granted, a court must accept as true all of the factual allegations in the complaint as well as the
reasonable inferences that can be drawn from them, and a court may dismiss the complaint “only if it
is clear that no relief could be granted under any set of facts that could be proved consistent with the
allegations.” Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S. Ct. 2229, 81 L. Ed. 2d 59 (1984).
Dismissal is appropriate “as a practical matter ... only in the unusual case in which a plaintiff includes
allegations that show on the face of the complaint that there is some insuperable bar to relief.” Bramlet
v. Wilson, 495 F.2d 714, 716 (8th Cir. 1974).
II. BACKGROUND
The Debtor operated the Facility in Coffeyville, Kansas. When the Debtor began construction
of the Facility in 1999, it found that the City of Coffeyville did not have sufficient electrical capacity
to handle the Facility’s demands. To remedy the problem, the Debtor negotiated, and on March 31,
1999, executed, the ESA with Coffeyville. Pursuant to the ESA, Coffeyville would build a new power
substation financed through the sale of bonds, held by Intrust. In return, the Debtor covenanted in the
ESA that it would provide a surety bond to Coffeyville to assure its continuing performance under the
ESA in the amount of $12,000,000. That surety bond was to cover, inter alia, charges for electricity
used by the Debtor and to cover Coffeyville’s obligations on the bonds it issued to finance the
construction of the new power substation. Safeco provided the surety bond and is a compensated
commercial surety.
On May 31, 2002, the Debtor filed its Chapter 11 bankruptcy and began to sell its assets. On
September 25, 2003, the Debtor executed an Asset Sale and Purchase Agreement (“APA”) with
CRLLC for the purchase of the Facility. Pursuant to the APA, CRLLC was to assume the ESA with
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Coffeyville, and the APA was approved by this Court on October 7, 2003. The APA was consistent
with the underlying terms of the ESA between the Debtor and Coffeyville, which required any
purchaser of the Facility to assume the Debtor’s obligations under the ESA. At the time, CRLLC was
the only prospective, qualified purchaser of the Facility.
On October 23, 2003, however, CRLLC and Coffeyville purportedly negotiated an aleatory
memorandum of agreement (“Memorandum”) concerning the confection of a new electrical services
agreement in the event CRLLC was successful in purchasing the Facility and in the event the Debtor
rejected the existing ESA with Coffeyville. In the Memorandum, and in the event the aleatory
conditions became certain, Coffeyville expressly promised not to assert rejection damages against the
Debtor’s bankruptcy estate, but Coffeyville retained the right to collect on the surety bond issued by
Safeco. Nothing in the Memorandum was to prejudice any right of subrogation Safeco might have
against the Debtor, in the event Safeco paid on the surety bond, or prejudice any right Intrust had to
demand payment of the bonds issued to finance the electrical substation. In looking only to the surety
bond in the event the Debtor rejected the ESA, Coffeyville was implicitly electing to look to the
prospective agreement with CRLLC to satisfy what would otherwise be part of its rejection claim
against the Debtor’s estate.
Safeco asserts that the circumstances presented an opportunity for CRLLC and Coffeyville to
negotiate a new agreement to the detriment of Safeco. At the time, CRLLC was the only qualified
bidder for the Facility and Coffeyville was the only source of electrical power needed to operate the
Facility. Safeco further contends that the purpose of the Memorandum was to accomplish what the
Debtor was prohibited from doing in the ESA – namely, selling the Facility without requiring CRLLC
to assume the ESA or to post security in lieu of Safeco’s surety bond. Safeco states that both
Coffeyville and CRLLC benefitted from the Memorandum because Coffeyville could negotiate a more
favorable contract for the sale of electrical services to CRLLC and CRLLC could avoid some expense
it would otherwise face by assuming the ESA and thereby servicing the bond payments to Intrust.
Coffeyville also stood to gain a “manufactured” claim against the Debtor’s bankruptcy estate and
Safeco’s surety bond to pay for the outstanding bonds held by Intrust.
On October 31, 2003, on the urging of CRLLC, the Debtor filed a motion to reject the ESA in
this Court, and on November 4, 2003, the Debtor and CRLLC confected an amended asset sale and
purchase agreement (“Amended APA”) altering the terms of the original APA by providing that the
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ESA would not be assumed by CRLLC. By confecting the Amended APA, which was approved by
the Court, the Debtor was agreeing to rejection damage claims against its bankruptcy estate, and by
implication, against Safeco’s surety bond. Safeco asserts that the Debtor agreed to the Amended APA
because it had no viable alternatives. On March 3, 2004, the Debtor and CRLLC closed the sale of
the Facility pursuant to the Amended APA, and CRLLC is currently purchasing electricity from
Coffeyville under the terms of the Memorandum. Coffeyville is not applying any amount of the
revenues generated by the sale of electricity to CRLLC to payment on the utility bonds held by Intrust.
On April 5, 2004, Coffeyville filed a proof of claim in the Debtor’s bankruptcy seeking
$9,029,144.44 in recovery for the aggregate outstanding balance on the utility bonds, plus accrued
interest and the fees of Intrust, based on the Debtor’s breach of the ESA. In turn, Safeco filed a proof
of claim in the Debtor’s bankruptcy case for the total penal amount of its surety bond, $12,000,000.
III. DISCUSSION
Coffeyville filed a motion to dismiss this case based on lack of subject matter jurisdiction, and
in the alternative for abstention. Both Coffeyville and Intrust filed motions to dismiss Safeco’s
complaint under Rule 12(b)(6) for failure to state claims upon which relief could be granted.
A. Subject Matter Jurisdiction
Coffeyville contends that this Court lacks subject matter jurisdiction in adjudicating Safeco’s
adversary complaint on the basis that the issues raised therein are not “bankruptcy related.” More
specifically, Coffeyville asserts that the Court’s order allowing the Debtor to reject the ESA also sets
a maximum cap on the amount of the Debtor’s liability for that rejection; thus, the only issues
remaining after rejection of the ESA were state law contract claims by Coffeyville and Intust against
the Safeco bond. Furthermore, Coffeyville asserts that resolution of its claims has no effect on the
administration of the Debtor’s bankruptcy estate on the grounds that the Debtor’s Chapter 11 plan is
already confirmed, the plan is one of liquidation and not reorganization, and any claim against the
Debtor would be asserted against the Debtor’s liquidating trustee.
Bankruptcy courts have jurisdiction over a vast array of substantive matters. A bankruptcy
court’s jurisdiction includes the district court’s grant of original and exclusive jurisdiction of all cases
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arising under the Bankruptcy Code, 28 U.S.C. § 1334(a), and also a grant of original – but not
exclusive – jurisdiction over civil proceedings arising under the Bankruptcy Code, even if Congress
did not otherwise confer an independent grant of jurisdiction on the district courts. § 1334(b).
Accordingly, the bankruptcy court’s exclusive jurisdiction extends to “all of the property, wherever
located, of the debtor as of the commencement of the case, and of such property of the estate.” §
1334(e). The court’s original, but non-exclusive jurisdiction, extends to matters “arising in,” “under,”
or “related to” the bankruptcy case. § 1334(b). More specifically, a controversy “arises in” Title 11
when “it would have no practical existence but for the bankruptcy,” Grausz v. Englander, 321 F.3d
467, 471 (4th Cir. 2003); claims arise “under” Title 11 if the claims “clearly invoke substantive rights
created by bankruptcy law,” Glinka v. Federal Plastics Manufacturing, Ltd. (In re Housecraft
Industries USA, Inc.), 310 F.3d 64, 70 (2nd Cir. 2002); and claims are “related to” a bankruptcy case
if the resolution of the dispute affects the administration of the bankruptcy estate. Belcufine v. Aloe,
112 F.3d 633, 636 (3rd Cir. 1997). As stated by the Eighth Circuit, a claim is “related to” a
bankruptcy case when “the outcome of that proceeding could conceivably have any effect on the estate
being administered in bankruptcy.... An action is related to bankruptcy if the outcome could alter the
debtor's rights, liabilities, options, or freedom of action ... and which in any way impacts upon the
handling and administration of the bankrupt estate.” Dogpatch Properties, Inc. v. Dogpatch U.S.A.,
Inc. (In re Dogpatch U.S.A., Inc.), 810 F.2d 782, 786 (8th Cir. 1987) (quoting Pacor v. Higgins, 743
F.2d 984, 994 (3rd Cir. 1984)). See also National Union Fire Insurance Company of Pittsburgh
Pa. v. Titan Energy, Inc., 837 F.2d 325, 330 (8th Cir. 1988) (“[E]ven a proceeding which portends
a mere contingent or tangential effect on a debtor's estate meets the broad jurisdictional test ....”).
In this matter, the Debtor rejected the ESA with Coffeyville and the rejection triggered
Safeco’s obligation to pay its surety bond on the Debtor’s default. Coffeyville has the right “under”
the Bankruptcy Code to file a proof of claim pursuant to 11 U.S.C. §§ 365(g) and 502(g) in the
Debtor’s bankruptcy case for rejection damages, and in fact, Coffeyville and Intrust filed a joint proof
of claim, No. 9189, on January 16, 2004, asserting their right to rejection damages. On June 10, 2004,
the Debtor objected to the proof of claim filed by Coffeyville and Intrust (Document No. 10279),
based in part on the grounds that Coffeyville failed to mitigate damages and to discount the amount of
its damages to present value. Inseparably tied to that proof of claim is Coffeyville’s claim against
Safeco on the surety bond. Anticipating that it might be liable for the penal sum of its surety bond,
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Safeco filed a $12,000,000 proof of claim against the Debtor’s bankruptcy estate.
Based on these facts, it is clear that Coffeyville and Intrust’s claim against the Debtor’s
bankruptcy estate arises out of the Debtor’s rejection of the ESA under § 365 of the Bankruptcy Code.
Allowance of a claim in bankruptcy is a core matter over which this Court has jurisdiction. 28 U.S.C.
§ 157(b)(2)(B). Parallel to that core proceeding is Coffeyville’s claim against Safeco on the surety
bond, which is also a direct consequence of the Debtor’s election to reject the ESA under 11 U.S.C.
§ 365. In the event Safeco is obligated to pay Coffeyville and Intrust on the surety bond, Safeco will
also be subrogated to Coffeyville and Intrust’s proof of claim against the Debtor’s bankruptcy estate.
In fact, the Debtor has set aside approximately $12,000,000 to pay the potential claims of Coffeyville
and Safeco. The Debtor is a named defendant in Safeco’s civil proceeding, despite the fact that the
thrust of the compliant alleges wrongdoing by Coffeyville and CRLLC, because a determination of
Safeco’s liability, if any, is a de facto determination of the amount of Safeco’s claim against the
Debtor’s bankruptcy estate.
Indeed, Coffeyville’s claims against the Debtor and Safeco for the Debtor’s rejection of the
ESA are inseparably linked – any defense the Debtor has against Coffeyville in the claims proceeding
inures to the benefit of Safeco, and any defenses Safeco has against payment on the surety bond inures
to the benefit of the Debtor inasmuch as Coffeyville relinquished the right in the new electrical
services agreement it reached with CRLLC to pursue the Debtor for rejection damages, except for
those it could assert against Safeco’s surety bond. In essence, this Court’s refusal to exercise subject
matter jurisdiction over Safeco’s complaint for declaratory relief would effectively result in an
abstention from the Debtor’s claims objection proceeding to avoid risking the possibility that two
separate tribunals might reach inconsistent judgments.
Coffeyville’s assertion that this dispute has no effect on the administration of the Debtor’s
bankruptcy estate is not convincing. Considering the panoply of disputes that Congress gave
bankruptcy courts jurisdiction to adjudicate, and considering the Eighth Circuit precedent that any
proceeding that alters the Debtor’s rights or liabilities is within the jurisdiction of the bankruptcy
court, this Court is unwilling to find that it does not have subject matter jurisdiction over litigation that
has the potential to result in a $12,000,000 claim against the Debtor’s estate. Because Safeco’s
complaint for declaratory relief is so intimately related to the claims allowance process of the
Debtor’s bankruptcy estate, Safeco’s declaratory action against Coffeyville, Intrust, and the Debtor
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1 The Court makes no ruling here that Safeco’s surety bond, issued on behalf of the Debtor,
is property of the Debtor’s estate. See O’Malley Lumber Co. v. Lockard (In re Lockard), 884
F.2d 1171, 1176-78 (9th Cir. 1989) (holding that a surety bond was not property of the estate and
not subject to the automatic stay). The Court is only ruling that Safeco’s declaratory action is
related to the Debtor’s bankruptcy proceeding, which is sufficient to give the Court jurisdiction to
adjudicate this dispute.
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is related to the administration of the Debtor’s bankruptcy estate and this Court has subject matter
jurisdiction over the dispute.1
B. Abstention
As an alternative to dismissal, Coffeyville requests that this Court abstain from adjudicating
the proceeding. Coffeyville argues that the State of Kansas has an interest in seeing that insurance
companies, like Safeco, fulfill their duty to timely investigate insurance claims in good faith.
Coffeyville also asserts that Safeco filed the declaratory action as a “cover” for a bad faith decision
to deny Coffeyville’s bond claim without investigation, and that the filing of the declaratory action was
a pre-emptive, forum-shopping to increase the costs and inconvenience to Coffeyville and Intrust.
Pursuant to 28 U.S.C. § 1334(c)(1), a bankruptcy court may, in the interests of justice and
comity, abstain from hearing a bankruptcy-related proceeding. In determining whether abstention is
appropriate under § 1334(c)(1), courts consider numerous factors, including the following:
(1) The extent to which the issues involve difficult or unsettled issues of state law.
(2) The extent to which state law or other esoteric and technical issues predominate.
(3) The effect of abstention on the efficient administration of the bankruptcy
proceedings.
(4) The presence of a commenced state law action in which the matter may be
determined.
(5) The degree of relatedness to the main bankruptcy proceeding.
(6) The burden on the bankruptcy court's docket.
(7) The likelihood that one of the parties is forum shopping.
(8) The presence or necessity in the proceeding of non-debtor parties.
(9) The existence of a jurisdictional basis other than 28 U.S.C. § 1334.
(10) The existence of a right to a jury trial and whether the parties do or do not consent
to jury trial in the bankruptcy court.
(11) The financial condition of the parties.
(12) The case's status as a "related" matter rather than a core proceeding.
Phelps Technologies, Inc. v. O'Connor (In re Phelps Technologies, Inc.), 238 B.R. 819, 823 (Bankr.
W.D. Mo. 1999). See also Williams v. Citifinancial Mortgage Co. (In re Williams), 256 B.R. 885,
894 (B.A.P. 8th Cir. 2001) (considering the feasibility of severing state law claims from core
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bankruptcy matters to allow judgments to be entered in state court with enforcement left to the
bankruptcy court); J.R. Simplot Co. v. Farmland Indus. (In re Farmland Indus.), 294 B.R. 892, 900
(Bankr. W.D. Mo. 2003) (stating that these factors are to be applied with flexibility; no one factor is
determinative and the relevance of any particular factor depends on the circumstances of the individual
case), vacated, 296 B.R. 497 (Bankr. W.D. Mo. 2003).
Based on the particular circumstances of this case, abstention is not warranted.
This case does not present any difficult or unsettled issues of state law. Safeco’s nine-count
complaint seeks declaratory relief on theories of waiver, release, breach of contract, impairment of
security, equitable subrogation, estoppel, and injunctive relief. Safeco’s arguments are essentially no
different than those asserted by any commercial surety contesting a potential claim to a surety bond.
Furthermore, despite Coffeyville’s allegations of bad faith investigation in its motion for abstention,
the Court is not aware that Coffeyville has filed any claim against Safeco based on that alleged breach
of duty, and no proceeding was ever initiated in a Kansas court to adjudicate the parties’ rights before
Safeco commenced its declaratory action in this Court. There are no particular esoteric or technical
issues in Safeco’s declaratory action that make this dispute more particularly adapted to a different
tribunal.
Abstaining in this matter would also affect other proceedings in the Debtor’s bankruptcy. Most
significantly, presently pending before the Court is the parallel claim objection proceeding initiated
by the Debtor against Coffeyville and Intrust. As stated supra, the declaratory action is intimately
related to the bankruptcy proceeding inasmuch as the declaratory action overlaps with the Debtor’s
objection to Coffeyville and Intrust’s proof of claim and both proceedings affect the relative debtor-
creditor relationships between the Debtor, Coffeyville, Intrust, and Safeco. Although the bankruptcy
court is sufficiently busy, the Court has no reason to believe that it is any more or less busy than any
other court, and retaining jurisdiction over this case is not overly burdensome to the Court’s docket.
Contrary to Coffeyville’s assertions, the Court discerns no ulterior forum-shopping scheme.
Representatives of both Coffeyville and Safeco have been to this Court on numerous occasions while
the Debtor and CRLLC negotiated and submitted the APA. The injury complained of – the Debtor’s
breach of the ESA – occurred in this Court, and Coffeyville’s claim to the Safeco bond is a direct
result of that contract being rejected. The Court does not harbor any doubts that the City of Coffeyville
has sufficient financial resources for its representatives to make a few short trips to Kansas City, if
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necessary, to litigate this matter. Finally, although Coffeyville asserts that it has a right to a jury trial
on Safeco’s declaratory action for breach of contract, Coffeyville has not filed any demand for a jury
trial.
Therefore, the Court does not find it appropriate to abstain from adjudicating this matter in
favor of another tribunal.
C. Failure to State a Claim
In its nine-count complaint, Safeco argues that the actions of Coffeyville have either waived
or in some way released, in whole or in part, Safeco’s obligation to pay on the surety bond securing
the Debtor’s performance of the ESA. In essence, Safeco argues that CRLLC did not want to assume
the existing ESA between the Debtor and Coffeyville when it purchased the Facility; thus, CRLLC
negotiated with the Debtor to reject the ESA and negotiated with Coffeyville to enter into a new
electrical services agreement. Coffeyville’s acquiescence to the negotiations for confecting a new
electrical services agreement with CRLLC – before the Debtor requested Court authority to reject the
ESA – is the primary act giving rise to Safeco’s declaratory action. Accepting as true all of the factual
allegations in the complaint, as well as the reasonable inferences that can be drawn from them, the
Court will deny Coffeyville’s and Intrust’s Rule 12(b)(6) motions.
Counts 1, 2, and 3 - Waiver, Material Alteration, and Impairment of Security
In Count 1, Safeco alleges that Coffeyville, by agreeing to the Memorandum with CRLLC,
waived its right to require that the Debtor be held to its obligation under the ESA to provide
assurances that any approved purchaser of the Facility would assume the ESA. In Count 2, Safeco
argues that the alleged waiver was a material alteration of the ESA that discharged Safeco from its
obligations under the surety bond. In Count 3, Safeco argues that the alleged waiver impaired the
value of Safeco’s security on the surety bond. The underlying premise of Safeco’s allegations is that
the events surrounding the confection of the Memorandum between Coffeyville and CRLLC provide
evidence of Coffeyville’s intent to contrive the Debtor’s rejection of the ESA in an attempt to gain a
windfall, but in doing so, Coffeyville released the Debtor from its obligation under the ESA to require
any prospective purchaser to assume that contract.
“Waiver in contract law implies that a party has voluntarily and intentionally renounced or
given up a known right, or has caused or done some positive act or positive inaction which is
inconsistent with the contractual right.” United American State Bank & Trust Co. v. Wild West
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2 The Debtor became an intended third party beneficiary to the Memorandum, and became
entitled to enforce that agreement when the aleatory events became certain. Restatement (Second)
Contracts § 304 (“A promise in a contract creates a duty in the promisor to any intended
beneficiary to perform the promise, and the intended beneficiary may enforce the duty.”).
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Chrysler Plymouth, Inc., 561 P.2d 792, 795 (Kan. 1977). Once a contractual right is waived, it
cannot later be asserted in a court of law. Id. A waiver is consensual in nature; a party must intend
to waive known rights. Prather v. Colorado Oil & Gas Corp., 542 P.2d 297, 303 (Kan. 1975). That
intention may be inferred from a party’s conduct, and the knowledge may be actual or constructive.
Stratmann v. Stratmann, 628 P.2d 1080, 1087 (Kan. 1981). See also Steele v. Nelson, 32 P.2d 253,
256 (Kan. 1934) (“It is the universal rule that one seeking to enforce a contract may waive a provision
of the contract that is in his favor. Such waiver does not render the contract unenforceable.”). In the
event a party waives a right securing an obligation under a contract, the obligor, and the obligor’s
surety, are released to the extent that the waiver of that right had value. See Restatement (Third)
Suretyship & Guaranty § 39 (1996). Quite simply, “a bond obligee may not increase the surety’s risk
or otherwise undermine the surety’s subrogation rights.” Pennsylvania National Mutual Casualty
Insurance Co. v. City of Pine Bluff, 354 F.3d 945, 952 (8th Cir. 2004).
Construing all inferences in favor of Safeco, there is enough evidence to state a claim for relief
consistent with Safeco’s allegations that Coffeyville waived its right under the ESA that any
prospective purchaser of the Facility had to assume the contract and that through the Memorandum
Coffeyville acted to release, in whole or in part, the Debtor and Safeco from the requirement that the
ESA be assumed by CRLLC.
More specifically, Safeco alleges that through the Memorandum, Coffeyville and CRLLC
communicated to the Debtor that CRLLC would not purchase the facility if it had to assume the ESA.
The Memorandum also served to inform the Debtor that if CRLLC acquired the Facility then
Coffeyville would be willing to enter into a new electrical services agreement with CRLLC. Some
incentive for the Debtor to reject the ESA was also part of the Memorandum. Coffeyville expressly
agreed that it would not assert its right for rejection damages in the Debtor’s bankruptcy proceeding
– except for its rights against Safeco’s surety bond.2 In effect, the Memorandum served to abridge any
“personal” liability of the Debtor above the amount of Safeco’s surety bond and provided at least
some amount of encouragement should the Debtor choose to reject the ESA. Furthermore, Safeco
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alleges that Coffeyville, not CRLLC, was the primary instigator in causing CRLLC to negotiate with
the Debtor for rejection of the ESA and that Coffeyville hatched the Machiavellian plot to not only
collect on Safeco’s surety bond to pay for the electrical substation it built to service the Debtor’s
power needs, but to also “double dip” by continuing to sell electricity to CRLLC without the
underlying debt obligations to Intrust. Safeco maintains that by allegedly instigating the Debtor’s
breach of the ESA, Coffeyville in effect waived the condition that any new purchaser must assume the
existing ESA.
By alleging that Coffeyville acted inconsistently with its known contractual right under the
ESA that CRLLC be required to assume that contract – insofar as Coffeyville provided the incentive
for CRLLC to negotiate the rejection of the ESA with the Debtor and provided the Debtor with
encouragement to breach the ESA – Safeco states a claim for relief. Safeco’s claims are consistent
with the maxim of law that if one who has the right to performance acts to prevent or hinder that
performance then that party cannot assert a claim for damages based on a subsequent breach. Moore
Bros. Co. v. Brown & Root, Inc., 207 F.3d 717, 725 (4th Cir. 2000) (explaining the “prevention
doctrine,” as “a generally recognized principle of contract law according to which if a promisor
prevents or hinders fulfillment of a condition to his performance, the condition may be waived or
excused.”).
Therefore, Safeco should be allowed to pursue its claims in Counts 1, 2, and 3 for release,
release by material alteration, and for impairment of its security by effectuating the purported release.
Count 4 – Impairment of Security
In Count 4, Safeco asserts that Coffeyville failed to require that the Debtor provide a payment
security instrument to cover some electrical service charges, which had the effect of increasing
Safeco’s exposure on the surety bond.
In the event a party waives a right securing an obligation under a contract, the obligor, and the
obligor’s surety, are released to the extent that the waiver of the right had value. See Restatement
(Third) Suretyship & Guaranty § 39 (1996).
Safeco asserts that the ESA required the Debtor to maintain a security instrument sufficient to
cover payment of “the aggregate CSWS Charges ... to be assessed by CSWS to [Coffeyville] under
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3 The Court is not aware of the nature of the fees charged by Central and Southwest
Services, Inc. (“CSWS”).
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the CSWS Transmission Services Agreement.”3 Safeco asserts that Coffeyville failed to obtain and
maintain the collateral required from the Debtor to secure the CSWS obligations, which had the effect
of increasing the amount of Safeco’s exposure on the surety bond inasmuch as that obligation was
secondarily bonded by Safeco. Accordingly, Safeco has stated a claim for relief inasmuch as
Coffeyville, by failing to enforce a term of the ESA, purportedly increased Safeco’s exposure on the
surety bond.
1. Counts 5 and 7 – Conventional Breach of Contract
In Count 5, Safeco asserts that Coffeyville committed the first breach of the ESA by negotiating
the Memorandum with CRLLC; thus, Coffeyville is now precluded from asserting any present or future
claims against the Debtor’s bankruptcy estate or against Safeco’s surety bond. In Count 7, Safeco
asserts that it is entitled to damages for Coffeyville’s breach of contract.
It is axiomatic that a conventional claim for a breach of contract requires: “(1) the existence
of a contract between the parties; (2) consideration; (3) the plaintiff's performance or willingness to
perform in compliance with the contract; (4) defendant's breach of the contract; and (5) that plaintiff
was damaged by the breach.” Britvic Soft Drinks, Ltd. v. ACSIS Technologies, Inc., 265 F. Supp 2d.
1179, 1187 (D. Kan. 2003). In every contract, there is an implied covenant of good faith and fair
dealing. Daniels v. Army National Bank, 822 P.2d 39, 43 (Kan. 1991). Pursuant to the duty of good
faith, one party cannot “intentionally and purposely do anything to prevent the other party from
carrying out his part of the agreement, or do anything which will have the effect of destroying or
injuring the right of the other party to receive the fruits of the contract.” Bonanza, Inc. v. McLean,
747 P.2d 792, 801 (Kan. 1987).
In this case, no party disputes that the ESA between the Debtor and Coffeyville was a valid
contract, that the Debtor breached that contract when it sought Court approval to reject the ESA under
11 U.S.C. § 365, or that Coffeyville – and by implication, Safeco – was injured by the Debtor’s
breach. Safeco’s arguments, however, do not rest on the Debtor’s rejection of the ESA; rather, Safeco
argues that Coffeyville breached its duty of good faith before the Debtor rejected the ESA by
negotiating the Memorandum with CRLLC. The act of negotiating the Memorandum, according to
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Safeco, made the Debtor’s rejection of the ESA a “mere bankruptcy formality and a by-product of
Coffeyville’s collusive actions in breach of the ESA.”
No inference exists that Coffeyville breached the express terms of the ESA. The Memorandum
between Coffeyville and CRLLC was an aleatory contract – it had no effect unless and until certain
conditions precedent were fulfilled. Namely, the Debtor, which was not a party to the contract, had
to agree to reject the ESA with Coffeyville under the Bankruptcy Code and CRLLC had to be the
eventual purchaser of the Facility. The Debtor’s acquiescence was problematic inasmuch as the
Debtor would likely have to agree to a multi-million dollar reduction in the value of the overall sale
as its bankruptcy estate would become liable for rejection damages – even if only asserted by Safeco
through subrogation principles. Neither one of the events – rejection or closing with CRLLC – was
certain when the Memorandum was confected on October 23, 2003. The Debtor did not seek to reject
the ESA until October 31, 2003, CRLLC and the Debtor still had to confect the Amended APA and
seek Court approval, and in fact, the final sale of the Facility to CRLLC did not take place until March
3, 2004.
Quite simply, Coffeyville did not fail to perform its express obligations under the ESA before
the Debtor rejected that contract; Coffeyville merely acted to protect its right to receive future
payments for supplying the Facility with electrical services regardless of what happened in the
Debtor’s bankruptcy. Entering into an aleatory contract to plan for the contingency that the Debtor
would breach the existing ESA and that CRLLC would be the eventual purchaser is not, and cannot
be, a conventional breach of the express terms of the ESA itself.
On the other hand, enough inferences are present for Safeco to assert a claim for the breach
of the implied covenant of good faith and fair dealing. While an implied covenant of good faith and
fair dealing is ordinarily not a bar to a contracting party to plan for contingencies, the covenant may
be breached, consistent with the prevention doctrine, on the basis that the “implied covenant of good
faith and fair dealing requires a promisor to reasonably facilitate the occurrence of a condition
precedent by either refraining from conduct which would prevent or hinder the occurrence of the
condition, or by taking positive action to cause its occurrence.” Cauff, Lippman & Co. v. Apogee
Financial Group, Inc., 807 F. Supp. 1007, 1022 (S.D.N.Y. 1992). Namely, Safeco stated a claim for
breach of the implied covenant of good faith by Coffeyville inasmuch as it alleged that Coffeyville did
not act consistently with the requirement in the ESA that CRLLC, a potential purchaser of the Facility,
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assume the existing ESA; rather, Coffeyville provided a permissive basis – through the Memorandum
– to encourage CRLLC to negotiate with the Debtor for rejection of the ESA and provided the Debtor
with some incentive for doing so by agreeing to limit any rejection damages.
Accordingly, the Court finds that Safeco has stated a claim upon which relief could be granted
in Counts 5 and 7 of its complaint for declaratory relief inasmuch as the facts Safeco alleges provide
some reasonable inferences that Coffeyville may have breached the implied covenant of good faith
and fair dealing.
Count 6 – Equitable Subrogation
Safeco asserts in its complaint for declaratory relief that it is entitled, to the extent of its
liability on the surety bond, to any rights of Coffeyville in the proceeds derived from its operation of
the electrical substation.
“The right of subrogation is not founded on contract. It is a creature of equity; is enforced
solely for accomplishing the ends of substantial justice and is independent of any contractual relations
between the parties.” Memphis & L.R.R. Co v. Dow, 120 U.S. 287, 301-02, 7 S. Ct. 482, 30 L. Ed.
595 (1887). The term “equitable subrogation” is defined as the legal fiction whereby a “person who
pays the debt for which another is primarily responsible is substituted ... to all rights and remedies of
[the] other.” Black’s Law Dictionary 539 (6th ed. 1990). In the case of Pearlman v. Reliance
Insurance Co., 371 U.S. 132, 141-42, 83 S. Ct. 232, 9 L. Ed. 190 (1962), the Supreme Court affirmed
a surety’s subrogation rights to not only substitute itself in place of a fully paid creditor against the
obligor, but also to subrogate itself to the rights of the obligor to any retainage or performance due
pursuant to the underlying contract that was owed by the creditor to the obligor. See Restatement
(Third) Suretyship & Guaranty § 31 (1996) (providing that a surety has the right to be paid the
obligee’s return performance). Indeed, as recognized in National Shawmut Bank of Boston v. New
Amsterdam Casualty Co., Inc., 411 F.2d 843, 845 (1st Cir. 1969), circumstances may arise, especially
in construction contracts, whereby a surety guaranteeing the payment and performance of a contractor
would be subrogated to the rights of: 1) the contractor, insofar as receivables are due; 2) of laborers
and material men, insofar as they have liens; and 3) the obligee for whom the job was completed. A
prerequisite to any claim of “equitable subrogation” is that the surety fully pay the underlying debt or
obligation. American Surety Co. of New York v. Westinghouse Manufacturing Co., 296 U.S. 133,
137, 56 S. Ct. 9, 89 L. Ed 105 (1935).
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In Count 6 of its complaint, Safeco requests declaratory relief recognizing – in the event it must
pay Coffeyville on the surety bond – that it is equitably subrogated to any rights of Coffeyville in the
proceeds derived from the operation of the electrical substation it built to accommodate the Debtor’s
electrical power demands. Under the doctrine of equitable subrogation, however, Safeco would be
subrogated to the rights of Coffeyville, but only to those rights related to the Debtor’s breach of the
underlying contract – i.e., Safeco steps into the shoes of Coffeyville as a creditor and would be
entitled to assert any right that Coffeyville has on the underlying contract. For example, if the Debtor
was past due on an electrical services payment before rejection of the ESA, Safeco, through
subrogation, would be entitled to receive that payment. Construing all reasonable inferences in favor
of Safeco, and thereby assuming that the Debtor failed to make payments under the ESA to Coffeyville
before the Debtor rejected the ESA, then upon total satisfaction of Coffeyville’s claims, Safeco would
be equitably subordinated to Coffeyville’s right to collect proceeds derived from operation of its
electrical substation that were due from the Debtor. Nothing in the doctrine of equitable subrogation,
however, would otherwise allow Safeco to be entitled to future proceeds derived from the operation
of the electrical substation garnered from CRLLC, outside of a reduction in the amount of its liability
due from Coffeyville’s duty to mitigate damages. Thus, Safeco has stated a cause of action in Count
6.
Counts 8 – Equitable Estoppel
In Count 8 of its complaint, Safeco asserts that Coffeyville and Intrust are equitably estopped
from asserting any claim on the surety bond based on their purported bad conduct. More particularly,
Safeco alleges that Coffeyville covenanted in the ESA that it would require assumption of the ESA
by a subsequent purchaser, Safeco relied on Coffeyville to enforce that covenant, and Coffeyville
frustrated that covenant when it entered into an aleatory contract – embodied in the Memorandum –
with CRLLC by promising to confect a new electrical services agreement in the event the Debtor
rejected the existing ESA and in the event CRLLC was the successful purchaser.
Safeco and Intrust assert that equitable estoppel is not a cause of action; rather, it is a defense
to a cause of action.
Pursuant to 29 U.S.C. § 2201, a party to a controversy may file a declaratory action to
determine the rights and legal relations of interested parties whether or not further relief is or could
be sought. "Equitable estoppel is the effect of the voluntary conduct of a party whereby it is
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4 In so deciding, the Court is mindful of its ruling that the Debtor and CRLLC negotiated the
Amended APA and rejection of the ESA at arms length and in good faith. That finding, however,
concerns the Debtor and CRLLC – it does not address Safeco’s contention that Coffeyville
breached the ESA through its actions in confecting the Memorandum.
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precluded, both at law and in equity, from asserting rights against another person relying on such
conduct.” Gillespie v. Seymour, 823 P.2d 782, 788-89 (Kan. 1991). “Estoppel requires (1) words,
acts, conduct, or acquiescence causing another to believe in the existence of a certain state of things;
(2) willfulness or negligence with regard to the acts, conduct, or acquiescence; and (3) detrimental
reliance by the other party upon the state of things so indicated.” In re Food Barn Stores, 174 B.R.
1010 (Bankr. W.D. Mo. 1994) (citations omitted).
In this case, the facts alleged in Safeco’s complaint, and inferences from those facts, are
sufficient to demonstrate that Coffeyville, through the ESA, caused Safeco to believe that any new
purchaser of the facility would assume the ESA, and that Safeco relied on that particular term in the
ESA. Concerning the willful or negligent conduct element, the Court finds – consistent with its
discussion on the prevention doctrine and the breach of the implied covenant of good faith and fair
dealing – that Safeco has stated a claim in Count 8 for equitable estoppel. More specifically, as
alleged by Safeco, it relied on the assumption clause in the ESA, Coffeyville acted either wilfully or
negligently with regard to Safeco’s reliance by creating an encouraging environment for CRLLC to
negotiate with the Debtor for rejection of the ESA and in providing the Debtor with some incentive
for agreeing to that rejection, and Coffeyville negotiated the Memorandum with CRLLC knowing that
Safeco was relying, to its detriment, on the assumption clause of the existing ESA.4
Count 9 – Injunction
In Count 9, Safeco requests a declaration of injunctive relief under Fed. R. Bankr. P. 7065
enjoining Coffeyville and Intrust from making a claim against the Debtor and Safeco under the surety
bond. In the event that Safeco avoids liability on the bond on a valid cause of action, Safeco can
assert a claim for a preliminary injunction. Thus, Count 9 will not be dismissed at this time.
IV. CONCLUSION
For the reasons set forth above, the Court finds that it has subject matter jurisdiction over
Safeco’s declaratory action, the Court is not willing to enter an order of permissive abstention, and
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Safeco has asserted valid claims upon which relief could be granted in its declaratory action against
Coffeyville, Intrust, and the Debtor. In ruling on this Rule 12(b)(6) motion, the Court is not
adjudicating the merits of Safeco’s claim, and expresses no opinion on the eventual success or failure
of Safeco’s causes of action. This opinion constitutes the Court’s conclusions of law based on the
facts in Safeco’s complaint and the inferences reasonably drawn therefrom. A separate, interlocutory
order shall be entered pursuant to Fed. R. Bankr. P. 9021.
ENTERED this 8th day of July, 2004.
/s/ Jerry W. Venters
HONORABLE JERRY W. VENTERS
UNITED STATES BANKRUPTCY JUDGE
A copy of the foregoing was mailed
electronically or conventionally to:
G. Stanton Masters
J. Michael Franks
Bruce E. Strauss
Laurence M. Frazen
Terry C. Cupps
Samuel P. Logan
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