Bagel v. Chicken Debtor v. Debtor Can Anyone Get a Home Field Advantage

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Apr 2003

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The last time that the World Series featured two teams that played their home games
in the same ballpark was during World War II. By the 1944 season, most of
baseball's stars had traded their flannels for fatigues, and all teams
were badly depleted. In the World Series in October of that year, the St. Louis
Cardinals (who had managed to hold onto their greatest of stars, Stan Musial,
during the war) defeated the St. Louis Browns (winners that year of the Browns's
only American League pennant in 52 seasons before becoming the Baltimore
Orioles). Both teams played their home games in Sportsman's Park in St.
Louis, so neither team could boast a home-field advantage during the World
Series. The Browns were perennial also-rans, and it took a world war to thin
sufficiently the rosters of the Yankees and the Tigers to allow the lowly
Browns to eke out their only-ever World Series berth. Inevitably, such
extraordinary circumstances can carry a substandard team only so far. Musial
batted .304, the Browns scored only 12 runs in six games, and the Cardinals won
the Series in front of their, and their opponent's, home crowd four games
to two.<a href="#1" name="1a">1</a>

Fifty-six
Octobers later, two other opponents met in another common "home
field." This time, the extraordinary circumstances were economic, and a
bankrupt bagel company and a bankrupt chicken company sought to resolve their
dispute before the same bankruptcy judge presiding over both companies'
chapter 11 cases. Einstein/Noah Bagel Corp., whose chapter 11 case was pending
before Judge Charles G. Case Jr. in Phoenix, filed certain administrative
expense claims against Boston Chicken Inc., whose chapter 11 case also was
pending before Judge Charles G. Case Jr. in Phoenix. When it was over, Boston
Chicken had swept Einstein Bagel three straight—in the bankruptcy court,<a href="#2" name="2a">2</a> Ninth Circuit Bankruptcy Appellate Panel<a href="#3" name="3a">3</a> and <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=C… Circuit Court of Appeals</a>.<a href="#4" name="4a">4</a>

The
issue between Einstein Bagel and Boston Chicken—certainly every bit as
riveting as the Fall Classic of 1944—was the interpretation of the
statutory language of Bankruptcy Code §365(d)(3),<a href="#5" name="5a">5</a> specifically whether
§365(d)(3) applies to a debtor as a lessor as well as a debtor as a
tenant. Stated differently, does Bankruptcy Code §365(d) (3) require a
debtor-lessor to "timely perform all obligations of the debtor," including
non-monetary obligations as lessor, and does a debtor-lessor's failure
give rise to an administrative expense claim in favor of the tenant? The
bankruptcy court noted that neither the bagel guys nor the chicken guys were
able to locate any prior cases addressing this point.<a href="#6" name="6a">6</a> The Ninth Circuit
agreed, calling the issue "one of first-impression in this
circuit."<a href="#7" name="7a">7</a>

In 1996, Einstein Bagel
and Boston Chicken—which owned half of Einstein Bagel's outstanding
shares—entered into several agreements with one another. One of these
agreements was a five-year lease, under which Boston Chicken subleased certain
office space in its Golden, Colo., headquarters to Einstein Bagel. Boston
Chicken leased the entire building from Prudential Insurance Co. In a 1998 amendment
to that sublease, Boston Chicken agreed to use its "best efforts"
to obtain a non-disturbance agreement from Prudential, which would have
protected Einstein Bagel from being ousted by Prudential if Boston Chicken
defaulted under its prime lease. Five months later, Boston Chicken filed its
chapter 11 petition, never having obtained the non-disturbance agreement from
Prudential. Einstein Bagel, devoid of its non-disturbance agreement, feared
that Boston Chicken's financial distress, bankruptcy and souring
relationship with Prudential would imperil Einstein Bagel's ability to
retain its office space. Einstein Bagel decided to relocate its offices in
1999. As anticipated, Boston Chicken sought and obtained an order in its
chapter 11 proceeding in 2000 that authorized Boston Chicken to reject its
sublease with Einstein Bagel under Bankruptcy Code §365(a).<a href="#8" name="8a">8</a>

Before
the May 2000 confirmation of Boston Chicken's plan (which provided
primarily for the sale of most of Boston Chicken's assets to a subsidiary
of the McDonald's Corp.), Einstein Bagel filed a request for payment of
certain administrative expenses. Principal among these expenses was a claim for
$1.5 million in relocation costs that Einstein Bagel attributed to Boston
Chicken's failure to use its best efforts to obtain the non-disturbance
agreement from Prudential. (Einstein Bagel's own chapter 11 case began
shortly thereafter.)<a href="#9" name="9a">9</a> The crux of the claim was that in failing to use its best
efforts, Boston Chicken had failed to "timely perform all [its] obligations"
in the unexpired sublease under Bankruptcy Code §365(d)(3).

The
bankruptcy court granted summary judgment to Boston Chicken (actually, by then,
the plan trustee), ruling that Congress did not intend to have §365(d)(3)
apply to debtors as lessors.<a href="#10" name="10a">10</a> The Bankruptcy Appellate Panel (BAP) affirmed on
essentially the same grounds.<a href="#11" name="11a">11</a> The Ninth Circuit also affirmed, citing the
same legislative history and tenets of statutory interpretation on which the
Bankruptcy Court and the BAP had relied.<a href="#12" name="12a">12</a>

The
Ninth Circuit cited the legislative statements of Sen.<a href="#13" name="13a">13</a> Orrin Hatch (R-Utah)
regarding the 1984 amendments that added §365(d)(3) to the Bankruptcy
Code: "The landlord is forced to provide current services—the use
of its property, utilities, security and other services—without current
payment."<a href="#14" name="14a">14</a> The Ninth Circuit concluded that §365(d)(3) was intended
to protect lessors only, also relying, as did the lower courts, on the last
sentence of §365(d)(3), which speaks exclusively of the "'lessor's rights' under 'such
lease' agreements, referring back to
the lease discussed in the first sentence. These statements should be read
together to determine the meaning of the statute."<a href="#15" name="15a">15</a> In doing so, the
Ninth Circuit concluded that "taken together, §365(d)(3)'s
first and last sentences indicate that the section applies only when a lessor
is accepting performance from the debtor lessee."<a href="#16" name="16a">16</a>

As
a result, Einstein Bagel was entitled, at best, to a general unsecured claim
for Boston Chicken's alleged failure to obtain the non-disturbance
agreement from Prudential, which purportedly forced Einstein Bagel to incur
$1.5 million in relocation costs. (Einstein Bagel's alternative argument
for an administrative expense priority under Bankruptcy Code §503(b)(1)(A)
was more easily rejected on a "benefit to the estate" analysis.<a href="#17" name="17a">17</a>)

Although
the decisions do not mention this, the stakes of bagel v. chicken were rather
high. Left with a general unsecured claim, Einstein Bagel was placed in the
unenviable position of all other general unsecured creditors in the Boston
Chicken case, who all received a distribution of an amount that resembled,
well, a bagel.

It
would be fair to characterize bagel v. chicken as a bad result for the
creditors of Einstein Bagel. Boston Chicken's creditors had already by
then obtained a bad result. It seems that everyone, to a lesser or greater
extent, is a loser when one chapter 11 debtor attempts to invoke the Bankruptcy
Code's unique powers in a dispute with another chapter 11 debtor. Yet we
should expect to see more of this—debtor vs. debtor, Bankruptcy Code
section vs. Bankruptcy Code section—as the number of business
bankruptcies grows during a faltering economic environment. Novel challenges
will continue to face restructuring professionals and their clients as
bankruptcy cases clash with one another.

Recently
in New York, in what might prove an interesting harbinger of things to come,
WorldCom Inc., one enormous multinational telecommunications debtor, filed a
motion in the chapter 11 case of Global Crossing Ltd., another enormous
multinational telecommunications debtor, seeking relief from the automatic
stay so that WorldCom could reject certain of its executory contracts with
Global Crossing debtor affiliates.<a href="#18" name="18a">18</a> Although the motion was withdrawn shortly
after, it raised the curious issue of whether relief from one chapter 11
debtor's automatic stay under Code §362 is appropriate—or even
required—before another chapter 11 debtor may reject an executory
contract with the first debtor under Code §365 in the second
debtor's bankruptcy proceeding.

The
case law is uniformly clear that relief from the stay is required before a
non-debtor party to an executory contract may terminate the contract with the
debtor. The case law is also clear that the automatic stay under §362 does
not operate as a stay against other courts—just other parties—and one could argue convincingly that a court-approved rejection under
§365 is an act by a bankruptcy court moreso than the debtor-in-possession
or trustee. So, are a debtor's rights under §365 restricted by
another debtor's rights under §362?

Only
one reported decision—from the last recession—seems to address this
concern. In In re Hawaii Dimensions Inc., the bankruptcy court in Honolulu ruled that relief from the stay in the
landlord's bankruptcy case was not a necessary prerequisite for the
tenant's rejection of an unexpired real property lease.<a href="#19" name="19a">19</a> The issue was
not central to that holding, however, and one might assume that WorldCom was
either not aware of or not persuaded by the Hawaii Dimensions holding, since WorldCom did not even cite that
decision, or any other, in its motion in the Global Crossing case.

These
types of confounding interplays between debtors and Bankruptcy Code
provisions—often, as in WorldCom and Global Crossing, in the same
court—will likely become more pervasive during economic troughs such as
the one that bankruptcy professionals are now perversely enjoying. As more and
more companies seek relief under the Bankruptcy Code, their business relationships
with other companies who have sought the same relief will more frequently
implicate countervailing policies and provisions inherent in the Bankruptcy
Code. Can courts resolve these disputes without giving primacy to certain
sections of the Bankruptcy Code over others? Is there a
"rock/paper/scissors"-type of approach on the horizon?

Try
this one: if Company A returns a preferential payment to Company B, a debtor,
and Company A itself becomes a debtor within 90 days, can Company A recover the
returned preference from Company B as a preference? If so, does Company B have
simply a general unsecured resulting claim (cents on the dollar) in exchange
for what was once a dollar-for-dollar preference claim? Does your head hurt
yet?

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> This had happened only twice before.
The New York Yankees and the New York Giants met in the World Series three
years in a row in 1921, 1922 and 1923. Because Yankee Stadium did not open
until 1923, all Series games in 1921 and 1922 were played in the Polo Grounds,
then both teams' home field. Despite having Babe Ruth, the Yankees lost
both Series—their two first Series in franchise history. The Yankees
exacted their revenge the following year, when the Yankees beat the Giants in
the 1923 World Series, half the games of which were played in the new Yankee
Stadium—the "House that Ruth Built." <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re BCE West L.P., 257 B.R. 304 (Bankr. D. Ariz.
2000)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re BCE West L.P., 264 B.R. 578 (9th Cir. BAP
2001)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=%…
Bagel Corp. v. Smith (In re BCE West L.P.), ___F.3d___</a>,
2003 U.S. App. LEXIS 2718 (9th Cir. Feb. 14, 2003). <a href="#4a">Return to article</a>

<a name="5">5</a> Section 365(d)(3) provides in pertinent part:

<blockquote>
The trustee shall timely perform all the
obligations of the debtor, except those specified in §365(b)(2), arising
from and after the order from relief under any unexpired lease or
nonresidential real property, until such lease is assumed or rejected,
notwithstanding §503(b)(1) of this title... Acceptance of any such
performance does not constitute waiver of relinquishment of the lessor's
rights under such lease or under the title. <a href="#5a">Return to article</a>
</blockquote>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. at 308-09</a> ("Neither party has found a case directly on point...
The court has likewise found the case law on this limited point to be
non-existent."). <a href="#6a">Return to article</a>

<a name="7">7</a> 2003 U.S. App. LEXIS 2718 at *6. It does
not appear from published decisions that any other circuit has considered the
issue to date. <a href="#7a">Return to article</a>

<a name="8">8</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. at 579-80</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 580</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. at 309</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. at 583</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> 2003 U.S. App. LEXIS 2718 at *8-*9. <a href="#12a">Return to article</a>

<a name="13">13</a> Sen. Hatch's music web site is
www.hatchmusic.com. <a href="#13a">Return to article</a>

<a name="14">14</a> 130 Conf. Rec. S 8891, 8895 (daily ed.
June 29, 1984), reprinted in 1984 U.S.C.C.A.N. 576, 598. <a href="#14a">Return to article</a>

<a name="15">15</a> 2003 U.S. App. LEXIS 2718 at *8 (emphasis
in original), citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…
Sav. Ass'n of Texas v. Timbers of Inwood Forest Assocs. Ltd., 484 U.S. 365, 371 (1988)</a> (statutory
construction of the Bankruptcy Code is "a holistic endeavor"). <a href="#15a">Return to article</a>

<a name="16">16</a> 2003 U.S. App. LEXIS 2718 at *9. <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at *11-*17</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> See "Motion of WorldCom Inc. for Relief from the Automatic Stay for Cause to
Exercise Right to Reject Executory Contracts with Debtors in the WorldCom
Bankruptcy Case," filed Dec. 31, 2002, in In re Global Crossing
Ltd. et al., Case No. 02-40188 (jointly
administered) (Bankr. S.D.N.Y.). <a href="#18a">Return to article</a>

<a name="19">19</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
B.R. 606 (Bankr. D. Hawaii 1984)</a>. <a href="#19a">Return to article</a>

Journal Authors

Jordan A. Kroop

Journal Date

Tuesday, April 1, 2003 - 12:00

Bankruptcy Rule

2003