Opinion
Case No. 05-14892-PHX-CGC.
November 15, 2005
OFFICE OF THE U.S. TRUSTEE Phoenix, Arizona.
Philip Rudd KUTAK ROCK, LLP Scottsdale, Arizona, Attorneys for Foothill Shadows Associates.
Steven N. Berger ENGELMAN BERGER, P.C. Phoenix, Arizona, Attorneys for Debtor.
UNDER ADVISEMENT RE: STAY RELIEF, MOTION TO EXTEND AND ADEQUATE PROTECTION
Under advisement is Foothill Shadows Associates' ("FSA") Renewed Motion for Relief from Automatic Stay or, Alternatively, (I) to Shorten Time Within Which Debtor Must Perform Under Purchase Contract and/or (II) to Require the Debtor to Provide Adequate Protection to Movant. By way of this motion, FSA seeks an order lifting the automatic stay in this case to allow it to terminate and cancel whatever rights Debtor may have to purchase the Scottsdale Desert Shadows Apartments pursuant to the parties' previously negotiated Sale Agreement and Escrow Instructions ("Sale Agreement"). In the alternative, if the Court finds that either 11 U.S.C. section 108(b) or section 365(d)(2) applies to extend the Closing Deadline under the Sale Agreement, FSA requests this Court shorten or eliminate the extension of time or, at minimum, provide it with adequate protection in exchange for any extension of time allowed.
This motion is a renewed motion because FSA had previously sought the same relief earlier in these proceedings, which the Honorable Redfield T. Baum denied without prejudice on the ground that the relief sought was premature.
Underlying this dispute is a Sale Agreement between FSA and Debtor whereby Debtor agreed to buy a 332-unit apartment project called Scottsdale Desert Shadows Apartments for $42,900,000. After several agreed upon extensions, the sale was required to close no later than 5:00 p.m. (Arizona time), August 15, 2005 (the "Closing Deadline"). If the sale failed to close by this time, FSA had the right to cancel the Sale Agreement and retain all earnest money deposits, which the parties acknowledge is roughly $1.8 million at this time, or seek specific performance under the Sale Agreement. The Sale Agreement specifically provides that time is of the essence.
Twenty-five minutes before the August 15, 2005, Closing Deadline was set to expire, Debtor filed this bankruptcy. Not surprisingly, the sale did not close.
FSA makes several arguments why Debtor no longer has any enforceable interest in the Sale Agreement. First, FSA contends that Debtor's failure to close by the Closing Deadline was a prepetition default and, therefore, 1) Section 108(b) does not act to extend the Closing Deadline by an additional 60 days postpetition and 2) there is no contract to assume or reject under Section 365(d)(2). Second, even if Section 365(d)(2) were to apply, Debtor cannot assume the contract because it cannot cure the nonmonetary default or provide adequate assurance of future performance under the Sale Agreement due to Debtor's continual lack of any financing commitment from a lender or equity contributor. As such, Debtor has no rights under the Sale Agreement to preserve and FSA is entitled to stay relief in order to cancel the Sale Agreement.
The parties agree the Sale Agreement is an executory contract under 11 U.S.C. section 365.
Debtor disagrees, arguing first that it was not in default at the time it filed bankruptcy. Therefore, pursuant to Section 108(b), Debtor had at least an additional sixty days within which to perform under the Purchase Agreement. And, although that time has admittedly now expired and any Section 108(b) issues are moot, Section 365(d)(2) grants Debtor until confirmation to assume or reject the Purchase Agreement, unless the time is shortened by the Court. Debtor disagrees with FSA that failure to close by the Closing Deadline was a nonmonetary default eliminating its right to assume or reject the Purchase Agreement under Section 365. Rather, it argues that the failure to close was purely a monetary default that can in fact be cured in order to assume the Purchase Agreement. In addition, Debtor contends it now has the financing commitment necessary to complete the transaction.
Neither party analytically hits the nail on the head here. Both correctly state various pieces of the law as it currently exists with respect to monetary and nonmonetary defaults and assumption and rejection of executory contracts, but neither party's analysis goes far enough. The precise issue here is whether Debtor's failure to close by the Closing Deadline constitutes a non-monetary default of the kind that cannot be cured in order to assume the Purchase Agreement under Section 365.
To begin with, at the time Debtor filed for bankruptcy protection, it was not in default under the terms of the Purchase Agreement. Debtor had until 5:00 p.m., Arizona time, on August 15, 2005, to close the deal. It filed bankruptcy before this deadline, albeit only several minutes, but that does not change the fact that Debtor was not in default at the time it filed its petition. Whether Section 108(b), in turn, granted Debtor a sixty day extension from the date of filing the petition to close the sale is now moot. Both parties agree that that time period, if it was applicable, has already run, leaving only the question of whether Debtor still has the option of assuming or rejecting the contract under Section 365.
11 U.S.C. section 108(b) provides which allows the debtor an additional sixty days after the filing of the petition to "cure a default, or perform any other similar act,"
FSA says no, relying on the holdings in In re Claremont Acquisition Corp., Inc., 113 F.3d 1029 (9th Cir. 1997) and In re New Breed Realty Enterprises, 278 B.R. 314 (Bankr. E.D.N.Y. 2002). The Court finds that the decision in Claremont Acquisition does little to answer the question here and that New Breed, even if this Court were to agree with its analysis, does not lead to the conclusion FSA urges.
The issue in Claremont was fairly narrow and only tangentially related to the issue here: Whether the language in Section 365(b)(2)(D) relieved debtor of its obligation to cure a particular default in order to assume and assign an executory contract. The debtor in Claremont was an automobile dealership that failed to operate its business for seven consecutive days, thereby breaching its GM Dealer Agreements. In leading up to its analysis of the 365(b)(2)(D) issue, the Ninth Circuit found that debtor's failure to operate for two weeks prepetition was a non-monetary default and, more importantly, an historical fact that could not be cured under Section 365(b)(1). Id. at 1033 (citing Lee West Enterprises, 179 B.R. 204 (Bankr. C.D. Cal. 1995)).
The question then became whether Section 365(b)(2) excused debtor from having to cure the default. Section 365(b)(2) provides, in relevant part, that a debtor need not cure a default "that is a breach of a provision relating to — . . . (D) the satisfaction of any penalty rate or provision relating to a default arising from any failure by the debtor to perform non-monetary obligations under the executory contract." The question was one of statutory construction and whether the word "penalty" modified both "rate" and "provision relating to a default arising from any failure by the debtor to perform non-monetary obligations under the executory contract." The court ultimately concluded that it did and that debtor's breach — going dark for two weeks — was not a "penalty provision" and thus not excepted from the cure provision under subsection (b)(2)(D). Therefore, because debtor could not cure the non-monetary default, it could not assume and assign the executory contract. This Section 365(b)(2)(D) issue was the crux of the Claremont decision and is not present here. The best that can be said of Claremont for purposes of this decision is that uncurable non-penalty non-monetary defaults based on historical fact preclude assumption under Section 365. That does little to resolve the question presented here.
FSA argues, however, that the Bankruptcy Court for the Eastern District of New York in New Breed properly extended the finding in Claremont to establish that a failure to close by the contract's deadline where time is expressly of the essence is a non-monetary, historical default that cannot be cured. This Court finds the New Breed analysis far from compelling, as did the court in In re Walden Ridge Development, LLC, 292 B.R. 58, 67 (Bankr. D.N.J. 2003):
This Court finds the "historical fact" exception limited, at best, to franchise cases and certain other non-monetary defaults not easily cured but inapplicable to Debtor's failure to pay the purchase price and close under the time of the essence letter in the instant matter. This Court does not follow the lead of New Breed in characterizing the failure of a buyer to pay the purchase price under an executory contract as a nonmonetary default. Such default simply does not equate to the "historical fact" default in the automobile franchise cases which may be characterized as non-monetary. Here the failure to close was occasioned by the failure to pay the purchase price and thus constitutes a monetary default which is curable through the payment of the purchase price together with fair compensation as provided in 365(b)(1)(A) and (B).
292 B.R. at 67. Historically, incurable, non-monetary defaults include such things as failing to remain open as required under a franchise agreement ( Claremont), illegal drug activity occurring at the debtor's leasehold ( In re Mack, 1993 WL 722255 (Bankr. E.D. Pa. 1993)), a failure to meet certain performance standards ( In re GP Express Airlines, Inc., 200 B.R. 222 (Bankr. D. Neb. 1996)), and the like.
Walden Ridge involved a situation akin to the one presented here. The debtor entered into a purchase agreement pre-petition to buy some shares of common stock in a corporation. The agreement required the debtor to make a non-refundable deposit and close the sale by a date certain. The agreement was modified to extend the closing deadline. Like the agreement here between Debtor and FSA, the agreement in Walden Ridge contained time-is-of-the-essence language. The modification required an additional deposit prior to the closing deadline. Debtor failed to make this payment. Subsequently, it filed bankruptcy and failed to consummate the sale by the post-petition closing deadline. The court concluded that the default was a monetary default. This Court finds the same: Debtor's failure to close by the Closing Deadline was occasioned by its failure to pay the purchase price — a monetary default. The failure to close is inextricably intertwined with the failure to pay the purchase price.
The Court also recognizes, however, that FSA's argument may be restated that Debtor's failure to comply with time is of the essence provision constitutes a non-monetary default separate from Debtor's failure to tender the purchase price on time. Both New Breed and Walden Ridge, however, address this issue and the result is the same. Even if this Court were to agree that the default here was an incurable, non-monetary failure to close the deal by the Closing Deadline and in light of the time-is-of-the-essence provision,
the analysis does not end here. Where the default is non-monetary and is not curable, the debtor is precluded from assuming an executory contract only if the default was material or if the default caused "substantial economic detriment."
New Breed, 278 B.R. 321 (quoting In re Joshua Slocum Ltd., 922 F.2d 1081, 1092 (3d Cir. 1990) and citing In re Vitanza, 1998 WL 808629 (Bankr. E.D. Pa. Nov. 13, 1996); Vanderpark Prop., Inc. v. Buchbinder (In re Windmill Farms, Inc.), 841 F.2d 1467, 1473 (9th Cir. 1988) (holding that debtor's non-monetary, incurable default of failing to make repairs, abandoning the lease, and improper attempt to assign the lease, were not material enough to preclude the trustee's assumption of the lease)); see also Walden Ridge, 292 B.R. at 67. The question of materiality and economic significance turn on applicable state law and are matters within a court's discretion. Id. at 321-22.
A review of relevant Arizona law finds that Arizona courts do not automatically treat time-is-of-the-essence language in contracts as a material term. While admittedly time-is-of-the-essence language "operates to give a minor breach as to timely performance the legal effect of a material breach," that alone does not render a trivial breach "material" in a legal sense. See Foundation Development Corp. v. Loehmann's, Inc., 163 Ariz. 438, 788 P.2d 1189 (1990). The relevant breach for this analysis is the non-monetary failure to close by the Closing Deadline and the question is whether that failure is material or made material by the time-is-of-the-essence provision. To determine this, this Court must weigh "the importance of many factors" in the case. Id. at 449, 788 P.2d at 1200 (quoting 3A Corbin on Contracts § 713, at 356 (1951)):
If the enforcement of such an express provision [a time-is-of-the-essence provision] will have the effect of enforcing an excessive penalty or an unjust forfeiture, equity will prevent such enforcement.
Id. (quoting 3A Corbin on Contracts § 715, at 360).
The Arizona Supreme Court concluded that it would be hard pressed to find a commercial lease that did not have a time-is-of-the-essence provision for the payment of rent and other charges, such that the stock phrase really does not add much to the parties' obligations. While perhaps more necessary in contracts for the sale of goods where the failure to pay for the goods in a timely manner may enable a buyer to time its purchases to the disadvantage of the seller, it still does not necessarily render the breach material:
If the failure of payment at the exact time will not cause injury, time cannot be absolutely `of the essence,' even though, technically, delay will be a breach. Vermont Marble Co., v. Baltimore Contractors, 520 F. Supp. 922 (D.D.C. 1981) . . .; Walton v. Denhart, 359 P.2d 890 (Or. 1961). . . . We thus hold that a time of the essence provision is merely one factor to be considered when determining if a breach is material. The mere incantation that "time is of the essence" works no magic to transform trivial untimeliness into material breach; rather, the same factors we delineated in determining general materiality apply to evaluating the effect of a particular "time of the essence" provision.
Id. at 449-50, 788 P.2d at 1200-01.
Under the facts in this case, the Court cannot agree with FSA that Debtor's failure to close by the Closing Deadline is a material breach sufficient to justify preventing Debtor from being able to assume the Purchase Agreement, requiring Debtor to forfcit its $1.8 million in non-refundable payments to FSA, and allowing FSA to sell the property to another buyer. FSA is still able to lease the property. And, while it was originally limited to renting solely to month to month tenants, Debtor offered in its papers to waive the month to month leasing requirement. While FSA complains in its pleading that this "phasing schedule continues to impose detrimental limitations upon" its control over its property, FSA does not identify what those detrimental limitations are. At the hearing, Debtor also agreed as part of its offer of adequate protection to waive the contractual provisions regarding the lease terms.
Debtor is also willing to pay an additional $500,000 non-refundable earnest deposit to FSA, which will adequately address FSA's concerns that it is losing interest on the sales proceeds that it has yet to receive, in addition to potential returns on its investment of the sales proceeds. While FSA contends there are others potential buyers wanting and waiting to purchase the property, it has not presented any evidence of such other bidders. At the moment, and based on the record provided, this argument seems little more than speculation.
In addition, and perhaps most importantly, Debtor has identified a lender, Prime Group, Inc., which it claims to be ready and able to finance the remaining purchase price and who states it is committed to closing by December 16, 2005. In light of this commitment, and the significant financial hardship that would result to if Debtor were to forfeit its $1.8 million deposit and opportunity to purchase this property, the Court denies FSA's motion to lift the stay and to shorten the time for Debtor to perform under the Purchase Agreement. The Court does, however, grant FSA's motion for adequate protection. In addition to waiving the contractual leasing restrictions, Debtor is to pay an additional $500,000 non-refundable earnest deposit to FSA by November 22, 2005. In addition, the transaction must close by December 31, 2005 or the agreement will be deemed rejected.
So ordered.