Opinion
NOT FOR PUBLICATION
Argued and Submitted at Seattle, Washington: July 27, 2007
Appeal from the United States Bankruptcy Court for the Western District of Washington. Hon. Samuel J. Steiner, Bankruptcy Judge, Presiding. Bk. No. 00-11351. Adv. No. 01-01429.
Before: DUNN, JAROSLOVSKY[ and MONTALI Bankruptcy Judges.
Hon. Alan Jaroslovsky, U.S. Bankruptcy Judge for the Northern District of California, sitting by designation.
MEMORANDUM
This appeal requires that we determine whether the bankruptcy estate, where the debtor was a lessee under a commercial lease, is entitled to a return of the debtor's security deposit from the lessor, despite the debtor's prepetition breach and postpetition rejection of the lease pursuant to 11 U.S.C. § 365. On cross-motions, the bankruptcy court granted summary judgment in favor of the lessor and against the trustee. We AFFIRM.
I. FACTS
Onecast Media, Inc., dba Seasonticket.com (" Debtor"), negotiated with First Avenue West Building, LLC (" Lessor") to lease 31, 522 square feet of commercial office space (" Leased Premises") in downtown Seattle. The lease (" Lease") was executed June 27, 2000, and was to commence September 1, 2000, for the portion of the Leased Premises located on Floor 5, and November 1, 2000, for the portion of the Leased Premises located on Floors 1 and 2. The Lease had a five year, two month term, ending October 31, 2005. The annual base rent started at $26.60 per square foot and increased through the term of the Lease until it reached $32.00 per square foot in Year 5. The aggregate rent due under the Lease was $4, 684, 284. Lessor was to provide an allowance for tenant improvements in the amount of $189, 132.
With respect to the Floor 5 Leased Premises, the Lease did not commence as to the final 1, 572 square feet until May 1, 2001.
The Lease required that Debtor provide a refundable security deposit (" Security Deposit") in the amount of $419, 299.98. The Security Deposit Debtor provided took the form of $69, 883.33 cash and a letter of credit (" Letter of Credit") in the amount of $349, 416.65.
The letter of credit was issued by Imperial Bank, the predecessor in interest to Comerica Bank - California (" Comerica"). Comerica was fully secured in a certificate of deposit which collateralized the Debtor's obligations under the letter of credit and accordingly has no direct claim to the Security Deposit. However, Comerica was a co-plaintiff in the underlying adversary proceeding and asserted, together with the Trustee, an interest in the Security Deposit, by virtue of a Settlement Agreement with the Trustee with respect to its overall claim in the bankruptcy case. We were told at oral argument that Comerica is no longer a party to this appeal.
Debtor defaulted under the Lease almost immediately by failing to pay the rent due under the Lease on November 1, 2000. Lessor issued a prompt notice of default on November 6, 2000. In response, by its letter dated November 8, 2000, Debtor acknowledged the default, announced that it would not take occupancy of Floors 1 and 2 of the Leased Premises, and advised Lessor of its intent to vacate Floor 5 of the Leased Premises within 14 calendar days. Debtor specifically stated its intent to assist in re-leasing the Leased Premises with the motivation of recapturing a portion or all of the Security Deposit. On November 15, 2000, Lessor drew the full amount of the Letter of Credit, and shortly thereafter applied $81, 121.25 of the Security Deposit to unpaid Lease obligations for November 2000, including rent, parking and a late fee. Lessor transferred the balance of the Security Deposit ($318, 178.73) to its successor.
On or about November 21, 2000, Lessor sold the building in which the Leased Premises are located to First West Building 00, LLC, a related entity. Any reference to Lessor in this Memorandum is to the owner of the building at the relevant time.
Debtor filed a voluntary chapter 11 petition on November 16, 2000; the case was converted to chapter 7 by order entered November 29, 2000, and Nancy L. James was appointed as the chapter 7 trustee (" Trustee").
Almost immediately, the Trustee moved for rejection of the Lease pursuant to § 365. During the first week of December, Debtor vacated the Leased Premises. The Lease was rejected by order entered December 15, 2000.
In the meantime, on December 13, 2000, Lessor re-let the Leased Premises to a new tenant, Bidpath Corporation (" Bidpath"), under a new lease agreement (" Mitigation Lease") with a five-year term ending December 31, 2005. The annual rent under the Mitigation Lease, which started at $30.00 per square foot and increased through the term of the Mitigation Lease until it reached $34.00 per square foot in Year 5, exceeded the annual rent under the Lease. The aggregate rent due under the Mitigation Lease was $5, 239, 857.
Beginning in June 2001, however, Bidpath encountered difficulty meeting its payment obligations under the Mitigation Lease. On October 11, 2001, Lessor entered into a settlement agreement (" Settlement Agreement") with Bidpath, pursuant to which Lessor released Bidpath from its obligations under the Mitigation Lease in exchange for a forfeiture of Bidpath's security deposit and a stock purchase warrant (" Stock Purchase Warrant") which entitled Lessor, for a period of ten years, to purchase 195, 122 shares of Bidpath stock for a total exercise price of $1.95. By July 2002, Bidpath itself had ceased its business operations and was in liquidation.
The Trustee commenced an adversary proceeding to recover the Security Deposit on August 6, 2001. The amended complaint asserted causes of action for turnover, declaratory relief, an accounting, breach of contract, and conversion. In its answer, Lessor denied the allegations and sought dismissal for failure to state a claim upon which relief could be granted.
At the commencement of trial of this matter in July 2002, the bankruptcy court ruled that it lacked jurisdiction over the Trustee's claim for recovery of the portion of the Security Deposit that Debtor had provided to Lessor in the form of the Letter of Credit. After hearing from some witnesses, the bankruptcy court dismissed the adversary proceeding on Lessor's motion. On appeal, the Ninth Circuit affirmed the district court, which had reversed the bankruptcy court, and remanded for further proceedings. See James v. First Ave. West Bldg., LLC (In re Onecast Media, Inc.), 439 F.3d 558 (9th Cir. 2006). Following remand the parties filed the cross-motions for summary judgment which constitute the subject of the present appeal.
The answer also asserted as an affirmative defense that the complaint should be dismissed based on the Trustee's failure to mitigate damages.
On October 20, 2006, the Trustee filed her motion for summary judgment (" Trustee's Summary Judgment Motion"), asserting that because Debtor had been released from its obligations under the Lease when Lessor had achieved complete mitigation by entering the Settlement Agreement with Bidpath, Lessor breached the Lease by failing to refund the Security Deposit. On October 24, 2006, Lessor filed its cross-motion for summary judgment (" Lessor's Summary Judgment Motion"), asserting that the Trustee could not establish that Lessor breached the Lease by retaining the Security Deposit.
Lessor alternatively sought judgment as a matter of law under Fed.R.Civ.P. 52(c) on the basis that the Trustee had not sustained her burden of proof on the causes of action in the complaint when she rested her case at the July 2002 trial. The bankruptcy court did not address this motion when it granted Lessor's Summary Judgment Motion and dismissed the adversary complaint.
The bankruptcy court determined that paragraph 20(d) of the Lease provided both that Debtor's obligation to pay rent under the Lease remained despite the termination of its right to possession of the Leased Premises, and that Lessor was required to use reasonable efforts to re-let the Leased Premises in mitigation of its damages. The bankruptcy court further determined that paragraph 20(b) of the Lease expressly provided that,
If the consideration collected by the [Lessor] upon any such reletting plus any sums previously collected from [Debtor] are not sufficient to pay the full amount of all rent [under the Lease], [Debtor] shall pay [Lessor] the amount of any such deficiency.
Concluding that, under Washington law, Lessor's damages far exceeded the amount of the Security Deposit, the bankruptcy court denied the Trustee's Summary Judgment Motion and granted the Lessor's Summary Judgment Motion. The Trustee filed a timely Notice of Appeal.
II. JURISDICTION
The bankruptcy court had jurisdiction pursuant to 28 U.S.C. § § 1334 and 157(b)(1) and (b)(2)(A), (E), and (O). We have jurisdiction pursuant to 28 U.S.C. § 158.
III. ISSUES
Whether the bankruptcy court erred in ruling, as a matter of law, that Lessor's release of Bidpath from obligations under the Mitigation Lease by means of the Settlement Agreement did not effect a release of Debtor's payment obligations under the Lease.
Whether the bankruptcy court erred in ruling, as a matter of law, that the Stock Purchase Warrant did not constitute a substitute for all future rent due under the Mitigation Lease.
IV. STANDARDS OF REVIEW
We review summary judgment orders de novo. Tobin v. San Souci Ltd. P'ship (In re Tobin), 258 B.R. 199, 202 (9th Cir. BAP 2001). Viewing the evidence in the light most favorable to the non-moving party, we must determine " whether there are any genuine issues of material fact and whether the trial court correctly applied relevant substantive law." Id.
We review a bankruptcy court's conclusions of law de novo. In re Woodson Co., 813 F.2d 266, 270 (9th Cir. 1986).
V. DISCUSSION
We are asked to determined whether, under Washington law, the Debtor is entitled to a refund of the Security Deposit. In pursuing the return of the Security Deposit on behalf of the Debtor's bankruptcy estate, the Trustee asserts, in the alternative, that as of October 11, 2001:
1. Lessor's Settlement Agreement with Bidpath terminated Debtor's obligations under the Lease; or
2. the Stock Purchase Warrant constituted a substitution for all future rent due under the Mitigation Lease; or
3. in taking the Stock Purchase Warrant, Lessor was acting in its own behalf and not in mitigation, such that there was an acceptance of Debtor's surrender of the Leased Premises by operation of law.
A. Lessor's Claims Under the Lease After Debtor's November 2000 Breach
1. Neither Debtor's November 2000 breach of the Lease nor the § 365 rejection eliminated Lessor's claims under the Lease.
Paragraph 20(a) of the Lease provides that, upon Debtor's breach, Lessor could " at its election, " either terminate the Lease or terminate only Debtor's right to possession, without terminating the Lease. It is clear from the record that Lessor did not elect to terminate its rights and remedies under the Lease.
First, the Lease required that termination based on Debtor's breach be express and written. Paragraph 20 of the Lease provides:
No act or thing done by [Lessor] or its agents during the Term shall be deemed a termination of this Lease 9 or an acceptance of the surrender of the Premises, and no agreement to terminate this Lease or accept a surrender of said Premises shall be valid unless in writing signed by [Lessor].
As noted previously, the " Term" of the Lease was " [f]ive (5) years two (2) months beginning on the Commencement Date, ending on the Termination Date." The " Termination Date" was October 31, 2005.
Although Lessor sent a Notice of Default on November 6, 2000, after Debtor failed to pay its obligations under the Lease for November 2000, Lessor did not serve a notice of termination of the Lease based upon this breach.
Further, as the bankruptcy court concluded, rejection of the Lease pursuant to § 365 " constituted a breach rather than a termination of the Lease, " for purposes of considering Lessor's claims. We agree.
As relevant to the rejection of the Lease, § 365(g) provides that " the rejection of an . . . unexpired lease of the debtor constitutes a breach of such . . . lease . . . immediately before the date of the filing of the petition." See First Ave. West Bldg., LLC v. James (In re OneCast Media, Inc.), 439 F.3d 558, 563 (9th Cir. 2006) (" [T]he rejection of Debtor's unexpired lease constitutes a pre-petition breach of the lease agreement leaving Creditor with potential remedies under applicable state law. The statutory breach of contract simply put the estate in the position of a breaching party to the executory contract."); Anderson v. Elm Inn, Inc. (In re Elm Inn, Inc.), 942 F.2d 630 (9th Cir. 1991) (a debtor's possessory interest in leased property terminates upon rejection).
Under § 365(d)(4), upon rejection of an unexpired lease of nonresidential real property under which the debtor is lessee, " the trustee shall immediately surrender that nonresidential real property to the lessor." As recognized by the Ninth Circuit, such required surrender " has the effect of terminating the enterprise that operates there." Sea Harvest Corp. v. Riviera Land Co., 868 F.2d 1077, 1080-81 (9th Cir. 1989). However, that does not mean necessarily that the lease " terminates" and eliminates the rights and remedies of the lessor.
The Bankruptcy Code recognizes that a lessor may have a surviving claim for damages, even if such claim results from the termination of a real property lease. See § 502(b)(6)(capping a lessor's claim for damages " resulting from the termination of a lease of real property."). But see Port Angeles Waterfront Assoc. v. Port of Port Angeles (In re Port Angeles Assoc.), 134 B.R. 377 (9th Cir. BAP 1991).
2. Debtor's bankrupt estate remains subject to a claim for payment of rent under the Lease to the extent not mitigated by Lessor.
Paragraph 20(d)(I) of the Lease provides:
Upon any termination of [Debtor's] right to possession only without termination of the Lease, [Lessor] may, at [Lessor's] option, enter into the Premises, remove [Debtor's] signs and other evidences of tenancy, and take and hold possession thereof . . . without such entry and possession terminating the Lease or releasing [Debtor], in whole or in part, from any obligation, including [Debtor's] obligation to pay the rent, including any amounts treated as additional rent hereunder for the full Term.
Thus, although Debtor surrendered the Leased Premises, it remained obligated for the payment of rent under the Lease.
Debtor's response to the Notice of Default, dated November 8, 2000, reflects its understanding that it remained bound for the payment of rent under the Lease.
Paragraph 20(d)(ii) of the Lease, however, expressly required Lessor to mitigate its damages by re-letting the Leased Premises, and further provided that if the consideration " collected" by Lessor as a result of re-letting the Leased Premises, plus the sums collected from Debtor, were not sufficient to pay the full amount of the rent due under the Lease, Debtor was responsible for any deficiency.
This contractual duty of mitigation is consistent with Washington law. See Exeter Co. v. Samuel Martin Ltd., 5 Wn.2d 244, 105 P.2d 83, 85 (Wash. 1940); Family Med. Bldg. Inc. v. Dept. of Soc. & Health Svcs., 104 Wn.2d 105, 702 P.2d 459, 464 (Wash. 1985).
B. The Settlement Agreement Did Not Operate to Terminate Debtor's Obligations Under the Lease
Consistent with its duty to mitigate under paragraph 20(d)(ii) of the Lease, Lessor, promptly upon rejection of the Lease, entered into the Mitigation Lease, which had both a greater rent and a longer term than the Lease. The parties agree that had Bidpath performed fully under the Mitigation Lease, the Security Deposit would be refundable. Unfortunately for all parties concerned, Bidpath breached the Mitigation Lease during its first year.
In response to Bidpath's breach, after extended negotiations, Lessor entered into the Settlement Agreement with Bidpath, pursuant to which Lessor terminated the Mitigation Lease and released Bidpath from its obligations under the Mitigation Lease.
The Settlement Agreement by its express terms terminated the Mitigation Lease. We are not persuaded by Lessor's assertion that the parties actually meant " modified, " but used " terminated" only to satisfy Bidpath's investors, who insisted the Mitigation Lease be terminated.
The Trustee contends that when Lessor released Bidpath from any liability under the Mitigation Lease, Lessor also released Debtor from its obligations under the Lease. The Trustee posited various theories for this result, which the bankruptcy court rejected. First, relying on an Oregon case, U.S. Nat'l Bank v. Homeland, Inc., 291 Ore. 374, 631 P.2d 761, 765 (Or. 1981), the Trustee argued that when Lessor re-let to Bidpath in mitigation, Debtor's status in relation to Bidpath became one in the nature of assignor to assignee. The Trustee then asserted that as assignee, Bidpath assumed primary responsibility for payment of rent to Lessor, and Debtor remained responsible to Lessor for rent under the Lease only if Bidpath did not pay. Thus, the Trustee's argument continued, because it is a fundamental principle of assignment law that release of an assignee also releases the assignor, Lessor's release of Bidpath in the Settlement Agreement necessarily released Debtor.
We decline to apply the law of assignment in the mitigation context. Unlike an assignment, mitigation involves entirely different leases, each with different rights and duties. No assignor-assignee relationship existed between Debtor and/or the Trustee, in behalf of Debtor's bankruptcy estate, and Bidpath.
We also disagree with the Trustee's contention that Lessor's duty to mitigate created a nexus between the Lease and the Mitigation Lease. Through this argument, the Trustee attempts to transmute Bidpath further from assignee to surety. The Mitigation Lease created no rights in Debtor or Debtor's bankruptcy estate. To hold otherwise would expose a mitigation tenant potentially to liability to an original breaching tenant.
In her opening brief on appeal, without citation to any authority, the Trustee asserts:
The termination of the [Mitigation] Lease is a critical fact in this case because [Lessor's] acceptance of consideration from Bidpath in full satisfaction of its obligation to pay $4.2 million in remaining rent shows that [Lessor] received consideration sufficient to pay the full amount of remaining rent due under the [Lease].
(emphasis added).
Under Washington law, when a lessor mitigates by re-letting premises, the original tenant is entitled to an offset against its obligations to the lessor only in the amount of funds actually received by the lessor. See Hargis v. Mel-Mad Corp., 46 Wn.App. 146, 730 P.2d 76, 81 (Wash.Ct.App. 1986). In addition, paragraph 20(d)(ii) of the Lease incorporates this general principle by crediting against Debtor's obligations the consideration " collected by" Lessor upon re-letting. Finally, the Trustee's position is inconsistent with the reality of settlements generally. It is not uncommon for parties to accept in settlement sums which are less than amounts that would make them " whole."
C. The Stock Purchase Warrant Did Not Constitute a Substitution For Future Rent Due Under the Mitigation Lease
Under the Settlement Agreement, the Stock Purchase Warrant expressly constituted part of the consideration for both the termination of the Mitigation Lease, and Lessor's release of Bidpath from all obligations, i.e., future rent, under the Mitigation Lease. The Trustee asserts that because the future rent forgiven in the Settlement Agreement was in the amount of $4, 286, 619.56, that conclusively establishes the value of the Stock Purchase Warrant. Because this value, plus the amount previously paid under the Mitigation Lease, exceeds the total rent obligation remaining under the Lease, the Trustee asserts that full mitigation has occurred such that the Security Deposit is fully refundable.
However, the Trustee's purported valuation is inconsistent with the record before the bankruptcy court. Bidpath's board of directors set the value of its stock at $.03/share at the time it authorized the issuance of the Stock Purchase Warrant. Thus, as asserted by Lessor, at the time it accepted the Stock Purchase Warrant, it had a value of $5, 854 based on the 195, 122 shares covered by the Stock Purchase Warrant.
More importantly, as stated by the bankruptcy court:
One thing that struck me as unusual here is that we don't have to [resort] to any valuation rules or speculations as to future rent or any presumptions because we have the benefit of knowing, up to a point, exactly what happened.
" Exactly what happened" in terms of the value of the Stock Purchase Warrant is that Bidpath ceased doing business in July 2002, which made the Stock Purchase Warrant worthless from that point forward. Further, this adversary proceeding has been pending long enough that the termination date under the Lease, October 31, 2005, has passed. Thus, for purposes of mitigation, we know with certainty that Lessor received no consideration under the Stock Purchase Warrant which can be credited against Debtor's obligations under the Lease.
D. Trustee's Assertion that Lessor Acted On Its Own Behalf in Accepting the Stock Purchase Warrant
As an alternative argument to support her contention that acceptance of the Stock Purchase Warrant terminated the Lease, the Trustee reiterates that Lessor had two options under Washington law when Debtor breached the Lease. Lessor could either terminate the lease and re-let on its own account, or relet in mitigation on Debtor's behalf. As we determined above, Lessor did not affirmatively elect to terminate the Lease.
The Trustee now asserts, for the first time on appeal, that Lessor's actions both in taking and in not disclosing the Stock Purchase Warrant, were inconsistent with its stated intent to act to mitigate Debtor's obligations under the Lease. Relying on Pague v. Petroleum Prods., Inc., 77 Wn.2d 219, 461 P.2d 317, 320 (Wash. 1969), reh'g denied (1970), the Trustee contends that Lessor therefore should be deemed to have resumed possession of the Leased Premises for its own benefit, with the result that Debtor's obligations under the Lease were terminated.
Because the Trustee did not raise this argument before the bankruptcy court, we will not consider it now. See In re E.R. Fegert, Inc., 887 F.2d 955 (9th Cir. 1989). In fact, not only did the Trustee not raise the issue before the bankruptcy court, she stated in her response to the Lessor's Summary Judgment Motion:
[T]he Trustee does not contend that [Lessor's] mitigation efforts were insufficient. Indeed, they were very successful.
The Trustee then proceeded to assert that her only objections with respect to the Settlement Agreement and the Stock Purchase Warrant were that Lessor failed to account to Debtor for the consideration it had received and for not releasing Debtor's obligation for future rent based on such receipt. We previously have addressed those objections.
E. Summary Judgment Is Appropriate Where Lessor's Unmitigated Damages Under the Lease Exceed the Amount of the Security Deposit
As set forth above, paragraph 20(d)(ii) of the Lease provides that if the consideration " collected" by Lessor as a result of re-letting the Leased Premises plus the sums collected from Debtor are not sufficient to pay the full amount of the rent due under the Lease, Debtor is responsible for any deficiency. The bankruptcy court found the deficiency Debtor owed under the Lease to be in excess of $4 million, an amount substantially greater than the amount of the Security Deposit. Accordingly, the bankruptcy court held that the Trustee was not entitled to turnover of the Security Deposit.
Ultimately, however, summary judgment is appropriate only where there is no genuine issue as to any material fact. Fed.R.Civ.P. 56. The parties used as factual support for the cross-motions only evidence that was available at the July 2002 trial.
The Trustee's Summary Judgment Motion specifically alerted the bankruptcy court that the record on summary judgment contained no evidence of amounts Lessor collected in mitigation between July 2002 and October 31, 2005, the termination date under the Lease. Despite the testimony in the summary judgment record regarding the downturn in the leasing economy both at the time the Settlement Agreement was entered into and subsequent thereto, suggesting it is doubtful that Lessor was successful in achieving full or even significant mitigation by further reletting the Leased Premises, a genuine issue of material fact did exist as to whether, upon final accounting through the end of the Term of the Lease, any deficiency Debtor owed under the Lease exceeded the amount of the Security Deposit.
At oral argument before the Panel, however, the Trustee's counsel conceded that if the Panel did not accept Trustee's assertion that Lessor had achieved complete mitigation, by virtue of either the Settlement Agreement or the Stock Purchase Warrant, any accounting would establish that Lessor's unmitigated damages exceeded the amount of the Security Deposit by a substantial margin. Accordingly, we deem withdrawn any assertion of error based on the bankruptcy court's finding that no genuine issue of material fact existed to preclude entry of summary judgment in favor of the Lessor.
VI. CONCLUSION
The bankruptcy court did not err in its determination that the Settlement Agreement did not terminate Debtor's obligation to pay rent under the Lease. Neither did the bankruptcy court err when it determined that, in accepting the Stock Purchase Agreement, Lessor did not accept substitute consideration valued at the full amount of the remaining rent due under the Mitigation Lease. Any issue that the bankruptcy court erred as a matter of law when it ruled on the cross-motions without a factual record for establishing the amount of consideration collected by Lessor from re-letting the Leased Premises through October 31, 2005, in mitigation of Debtor's obligations under the Lease, has been withdrawn.
We AFFIRM.