Opinion
NOT FOR PUBLICATION
Argued and Submitted at Seattle, Washington: February 25, 2005
Appeal from the United States Bankruptcy Court for the Western District of Washington. Bk. No. 03-23561. Honorable Samuel J. Steiner, Bankruptcy Judge, Presiding.
Before: PERRIS, SMITH and TIGHE, [ Bankruptcy Judges.
Hon. Maureen Tighe, U.S. Bankruptcy Judge for the Central District of California, sitting by designation.
MEMORANDUM
This is an appeal of an order allowing a chapter 11 debtor in possession to assume three unexpired leases of nonresidential real property. Because there was insufficient evidence that assumption would be beneficial to the estate, we REVERSE and REMAND for the court to conduct an evidentiary hearing.
Unless otherwise indicated, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. § § 101-1330.
FACTS
X10 Wireless Technology, Inc. (" debtor") develops, markets and sells wireless networking products for homes and small businesses. Debtor filed a chapter 11 petition in October 2003.
Shortly after the petition date, debtor filed a Motion for Order Extending Deadline to Assume or Reject Non-Residential Real Property Leases (" the first extension motion"). Debtor requested an extension with regard to the following three nonresidential real property leases:
1. Kent, Washington office space (lease expires 2/28/2007);
2. Nevada warehouse (lease expires 3/31/2007); and
3. New Jersey warehouse (lease expires 8/1/2006). Debtor was not in default on the petition date, and has remained current on all postpetition obligations associated with these leases.
The parties did not analyze the three leases separately before the bankruptcy court, and do not do so on appeal.
Debtor's chief financial officer stated as follows in his declaration in support of the first extension motion:
2. [Debtor] has approximately 100 employees and our business entails marketing and distributing innovative and affordable wireless home automation and security products to home and small business customers. We reach these customers primarily through direct advertising conducted on the Internet and generally receive and process thousands of customer orders each week. Our primary offices are located in Kent, Washington and we maintain two warehouses located in Nevada and New Jersey.
. . . .
4. The real properties subject to these three leases are [sic] among the [debtor's] primary assets. Because our sole business is the operation of a retail sales business from leases [sic] offices in [the] Kent, Washington location with two leased large warehouse facilities located in Nevada and New Jersey, until we can negotiate a confirmable Plan of Reorganization we are not in a position to fairly consider whether to assume or reject these leases. [Debtor's] analysis of these leases is directly related to our ability to successfully reorganize under a Plan of Reorganization. For these reasons, [debtor] requires additional time to negotiate a Plan before we decide whether to assume or reject real property leases.
Declaration of Wade Pfeiffer in Support of Debtor's First Extension Motion, at 1-2.
The owner of the Kent property objected to the length of the extension requested by debtor. The court entered an order extending the deadline for debtor to assume or reject the leases until March 24, 2004, " unless extended by subsequent motion." Order Granting Debtor's Motion for Order Extending Deadline to Assume or Reject Non-Residential Real Property Leases, at 1-3.
Before the extended date for assumption or rejection, debtor filed a Motion to Extend Time to Accept or Reject Leases (" the second extension motion"), requesting an additional 120 days. The second extension motion was supported by a declaration of debtor's president, Alex Peder (" Peder"). Peder ratified Pfeiffer's declaration and stated that debtor
requires additional time to negotiate a Plan before deciding whether to assume or reject its real property leases. This is due in part to the fact that [debtor] has recently retained new counsel to represent the corporation in this chapter 11 proceeding, and [debtor's] new counsel will require additional time to come " up to speed" in this case before a Plan can be negotiated and proposed.
Declaration of Peder in Support of Second Extension Motion, at 1-2.
The owner of the Kent property opposed the second extension motion, arguing, inter alia, that there was no cause for an extension, because debtor had had adequate time to formulate a plan. The court entered an order extending the time to accept or reject the leases to May 14, 2004. The court rejected language in the proposed order indicating that a further extension was possible, and stated on the record that May 14 was " a drop dead deadline." Transcript of April 9, 2004 Hearing, at 10.
Debtor timely filed a motion to assume the three leases pursuant to § 365(a). The motion to assume was supported by a declaration of Peder, stating, in substantive part, as follows:
[Debtor] has determined that it is in the best interest of the debtor to continue to lease these properties in order to continue its business operations uninterrupted during the pendency of this chapter 11 case, and therefore wishes to assume the leases. [Debtor] is current on its payments due under the Lease and will be able to continue to perform under the leases post assumption.
Declaration of Peder in Support of Motion to Assume, at 2.
The creditors' committee (" the committee") filed an Objection to Assumption of Leases and Motion to Extend Time to Assume to Confirmation, requesting that the court deny the motion and extend the time to assume the leases to " August 31, 2004, on the condition that the Debtor file a Plan providing for assumption or rejection of its leases no later than June 18, 2004." Objection to Assumption and Motion to Extend Time to Assume to Confirmation, at 4.
After a hearing, the court entered an order granting the motion to assume. The committee timely appealed.
ISSUE
Whether the bankruptcy court erred in granting debtor's motion to assume the leases.
While the committee also sought an extension of time for debtor to assume or reject the leases, it does not argue on appeal that the bankruptcy court erred in denying an extension.
STANDARD OF REVIEW
A bankruptcy court's decision that assumption is warranted under the business judgment rule is reviewed for clear error. In re Crystalin, L.L.C., 293 B.R. 455, 463 (8th Cir. BAP 2003). See also Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1047 (4th Cir. 1985), superseded by statute on other grounds as stated in, In re A.J. Lane & Co., Inc., 107 B.R. 435, 440 (Bankr. D. Mass. 1989).
The committee cites In re Sun Runner Marine, Inc., 116 B.R. 712 (9th Cir. BAP 1990), vacated in part on other grounds, 945 F.2d 1089 (9th Cir. 1991), in support of its position that a de novo standard of review applies. Sun Runner is not instructive as to the applicable standard of review in this case. In Sun Runner, this Panel applied a de novo standard of review in deciding, among other things, that the bankruptcy court erred in finding that the contract at issue was an executory contract. There is no dispute that the leases at issue in this appeal qualify as unexpired leases under § 365(a).
DISCUSSION
Section 365(a) states that " the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor." As a chapter 11 debtor in possession, debtor is authorized to exercise most of the powers of a trustee, including the power to assume or reject unexpired leases under § 365(a). See § § 1101; 1107.
If a debtor assumes a lease, it accepts both the burdens and the benefits of the bargain, and any liabilities incurred in the lease's postpetition performance will be treated as administrative expenses with priority status. See In re Barakat, 99 F.3d 1520, 1528 (9th Cir. 1996). Moreover, damages associated with leases that are rejected after they have been assumed are not subject to the § 502(b)(6) cap. In re Klein Sleep Products, Inc., 78 F.3d 18, 28-29 (2d Cir. 1996). As a result, " [a]ssumption . . . may ultimately result in a detriment to the holders of unsecured claims." In re Gateway Apparel, Inc., 210 B.R. 567, 570 (Bankr. E.D. Mo. 1997)(citing Klein). For these reasons, we have held that the interests of the general unsecured creditors are of paramount importance when considering a motion to assume or reject, and that a " balancing of interests" of all parties may be required. In re Chi-Feng Huang, 23 B.R. 798, 801 (9th Cir. BAP 1982).
With certain exceptions not relevant here, § 502(b) provides that, upon objection to a claim, a court shall allow the claim in the amount stated, except to the extent that
Whether to assume or reject an executory contract is left to the business judgment of the trustee or debtor in possession. In re G.I. Indus., Inc., 204 F.3d 1276, 1282 (9th Cir. 2000); Chi-Feng Huang, 23 B.R. at 800. In exercising that business judgment, the trustee or debtor in possession must demonstrate that assumption will benefit the estate. In re Crystalin, L.L.C., 293 B.R. 455, 464 (8th Cir. BAP 2003); In re Kirkpatrick, 34 B.R. 767, 769 (9th Cir. BAP 1983). " 'As long as assumption of a lease appears to enhance a debtor's estate, '" a bankruptcy court should normally grant its approval, unless the debtor in possession's " 'judgment is clearly erroneous, too speculative, or contrary to the provisions of the Bankruptcy Code . . . .'" Richmond Leasing Co. v. Capital Bank, N.A., 762 F.2d 1303, 1309 (5th Cir. 1985)(quoting Allied Tech., Inc. v. R.B. Brunemann & Sons, 25 B.R. 484, 495 (Bankr. S.D. Ohio 1982)).
The committee does not argue on appeal that debtor's decision to assume the leases was clearly erroneous, too speculative, or contrary to the Code. Instead, the committee's main argument is that the bankruptcy court erred in approving the motion to assume, because there is insufficient evidence upon which the court could have concluded that assumption was beneficial to the estate. We agree.
The committee argues that the bankruptcy court also erred, because debtor did not provide adequate assurance of future performance. We reject this argument.
The court will approve assumption of a lease if the debtor, in the exercise of its business judgment, establishes that assumption will benefit the estate. In order to determine whether assumption is appropriate under this standard, the debtor must provide evidence to support its business judgment that the estate will be benefitted.
In this case, the leases were never made part of the record in connection with the extension or assumption motions. In addition, there was no evidence that the leased property was uniquely suited to debtor's needs, of the availability of alternative space, or of the cost of moving debtor's business operations. In fact, there is evidence in the record that could support a conclusion that assumption was not beneficial to the estate. The president of the lessor of the Kent, Washington property submitted a declaration stating that " [t]he market for similar commercial space in the surrounding area is poor." Declaration of Joann Lee in Support of 196th Corridor LLC's Opposition to Debtor's Motion for Order Extending Deadline to Assume or Reject Non-Residential Leases, at 2. This suggests that debtor might have been able to lease replacement property at a net savings to the estate.
Debtor's attorney admitted at the hearing on the assumption motion that debtor's decision to assume was driven by the fact that rejection was the only other option, not by debtor's informed analysis that assumption would benefit the estate. See Transcript of June 4, 2004 Hearing, 3:23-25; 11:7-12:10.
The bankruptcy court in this case did not make a finding that debtor had established that assumption is likely to benefit the estate, nor did debtor submit evidence from which such a finding could have been made. In fact, the court's decision to approve assumption resulted from the same type of analysis as was applied by the debtor. At the end of the hearing on the motion to assume, the court announced that it would grant the motion to assume, ruling as follows:
THE COURT: Well, I did make an order as a result of a contested hearing, setting a final date for the debtor to assume or reject these leases. It's my understanding that that date has come and gone. Now both the debtor and the committee are saying that we ought to have some kind of an evidentiary hearing to establish the economic viability of these leases.
In my opinion, that approach is nothing more than a subterfuge to, in effect, give the debtor a further extension. I made the order. I have to stand by my orders. Therefore, I'm going to grant the debtor's motion to assume. I don't see where I have room to do anything else.
Transcript of June 4, 2004 Hearing, 15:11-24.
Because debtor failed to present evidence to establish that assumption was likely to benefit the estate, we remand for the bankruptcy court to conduct an evidentiary hearing. The question of whether the leases should be assumed may be addressed at a separate evidentiary hearing, or in conjunction with the confirmation hearing.
CONCLUSION
For the reasons set forth above, we REVERSE and REMAND.
(6) if such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, such claim exceeds
(A) the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease, following the earlier of
(i) the date of the filing of the petition; and
(ii) the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus
(B) any unpaid rent due under such lease, without acceleration, on the earlier of such dates[.]
A debtor in possession must provide adequate assurance of future performance only " [i]f there has been a default in an executory contract or unexpired lease . . . ." § 365(b)(1)(C). There was no default in this case. Even if the adequate assurance of future performance requirement applied, debtor satisfied that requirement in this case. The necessary degree of assurance " 'falls considerably short of an absolute guaranty.'" In re Tex. Health Enters., Inc., 246 B.R. 832, 835 (Bankr. E.D. Tex. 2000)(quoting In re PRK Enters., Inc., 235 B.R. 597, 603 (Bankr. E.D. Tex. 1999)). Debtor's president stated in his declaration filed in support of the motion to assume, that debtor " will be able to continue to perform under the leases post assumption." Declaration of Alex Peder, 2:15-16. In addition, the court inquired as to debtor's future prospects at the hearing on the motion to assume. See Transcript of June 4, 2004 Hearing, 13:6-19.