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Bankruptcy Court Mistakenly Makes Rejection of Lease Retroactive

Tuesday, February 19, 2013

A lessor was not required to file a motion seeking a payment of post-petition rent after a bankruptcy court mistakenly made the rejection date of a lease retroactive, the U.S. District Court for the District of Colorado ruled Feb. 4 (Epic Energy Resources Inc. v. Terrace Point Partnership LLC, D. Colo., No. 1:12-cv-01046-RBJ, 2/4/13).

Judge R. Brooke Jackson remanded the matter to the bankruptcy court, but affirmed the bankruptcy court's finding that no extraordinary circumstances existed that would warrant making the rejection date retroactive. 

Breached Lease

Epic Energy Resources Inc. (“Epic”), an energy company involved in consulting, engineering, and oil and gas production, operated through its wholly-owned subsidiaries: The Carnite Group LLC, Pearl Investment Company, and Epic Integrated Solutions LLC. On April 27, 2006, Pearl entered into an office lease with Terrace Point Partnership, pursuant to which Terrace leased office space to Pearl for a term of 61 months (through July 31, 2011).

In December 2009, Epic's subsidiaries merged into Epic Integrated Services Inc. (“Integrated”). It was unclear to the court if the lease was ever formally assigned to Epic and Integrated, but there was no dispute that Epic and Integrated were parties to the lease. Some time before Nov. 30, 2010, the office space was vacated and Epic and Integrated ceased paying rent. Terrace filed a suit for breach of contract and received a default judgment in the amount of $332,238 for the past due rent, late fees, and attorneys' fees and costs.

On Jan. 22, 2011, Epic delivered the keys and security cards to the office space to Terrace. 

Retroactive Rejection

On March 18, 2011, Epic and Integrated filed Chapter 11 petitions. On May 10, 2011, the debtors filed a motion to reject the lease with Terrace and argued in the motion that the office space was no longer being utilized and that rejecting the lease would be in the “best interest of parties in interest.” Terrace did not object to the motion. On June 7, 2011, the bankruptcy court ordered the lease rejected as of the petition date.

Shortly thereafter, Terrace filed a “Motion for Order Requiring Prompt Payment by the Debtor Pursuant to 11 U.S.C. § 365(d)(3).” In the motion, Terrace sought the rent due from the date of the petition, apparently unaware that the order rejecting the lease had been made retroactive to the petition date. 

Rule 60 Motion

After the debtors pointed out that the rejection date was the petition date, Terrace moved for relief from the June 7 order pursuant to Rule 60 of the Federal Rules of Civil Procedure. At a hearing on the Rule 60 motion, the bankruptcy court questioned whether a basis for the motion had been established, but nevertheless elected to exercise its inherent power to review its own orders.

The court found that it had “not appreciated the relief being sought in the motion to reject.” The bankruptcy court said a rejection can be retroactive but only in “extraordinary circumstances.” The court said that the debtors had failed to present any extraordinary circumstances in their motion and therefore the June 7 order was modified on Oct. 26, 2011, to state that rejection occurred on the day the order was issued, not the petition date. The Rule 60 motion was denied as moot. 

No Remedy for Lessor

However, the court indicated that there was evidence to suggest that the rejection date should be retroactive, like the fact that the landlord was aware the debtors had vacated the premises before the petition date. The debtors moved for a reconsideration of the Oct. 26 order and both parties submitted briefs on the issue.

After another hearing, the bankruptcy court denied the motion to reconsider on April 5, 2012. The court again concluded no extraordinary circumstances were present. Furthermore, the court found that the debtors were aware that Terrace was planning to pursue rent even though the debtors had vacated the premises. Therefore, the court said the debtors should have filed the motion to reject with or shortly after filing the petition rather than waiting almost 60 days. The debtors appealed the decision to the district court.

On April 18, 2012, Terrace filed another motion seeking immediate payment of the rent as of the petition date. Despite the bankruptcy court's earlier findings, it determined that it could not provide a remedy to Terrace because the debtors' plan had already been confirmed on March 5, 2012. The bankruptcy court reasoned: “Unfortunately, [Section 365(d)(3)] imposes a responsibility without an accompanying remedy. It offers no relief to a lessor who does not obtain payment while a trustee or debtor-in-possession is still the fiduciary in the case. When a plan is confirmed, the plan serves as a new contract among the reorganized debtors and their creditors. Thus, it is the plan, not § 365, that controls what happens to a lessor's unpaid claim.”

Terrace also appealed to the district court. 

Correction of Oversight Permitted

With regard to the debtors' appeal, the district court affirmed the bankruptcy court's order that the rejection should be the date of the June 7 order, not the petition date. The court agreed that the debtors had failed to provide any extraordinary circumstance that would merit making the rejection date retroactive. The debtors had not explained why it would be in the “best interest of parties in interest” to make the rejection date retroactive, nor had they explained their delay in rejecting the lease. The debtors had also argued that it would be in the best interest of the estate to make the date retroactive, but the court said this would be true of rejecting any lease and did not qualify as extraordinary circumstances.

Furthermore, the court found that pursuant to Rule 60, the bankruptcy court was permitted to correct its own oversight. The court also found no clear error in the bankruptcy court's factual findings that the debtors knew Terrace was seeking post-petition rent but still waited nearly 60 days to file a motion to reject the lease. 

'Unnecessary and Meaningless Act'

Turning to the appeal from Terrace, the district court found that equity compelled a different result than that reached by the bankruptcy court. The court said that pursuant to Section 365(d)(3), rent due during the first 60 days post-petition must be paid in a timely manner, and rent due after the 60 day period should be determined according to its fair and reasonable value which is rebuttably presumed to be the contract rate.

In this case, the court said that Terrace was owed rent from the petition date on March 18, 2011, until the rejection date on June 7, 2011. The court said this rent became due as of the modification of the rejection order on Oct. 26, 2011. The court found that Terrace was under no legal obligation to file a motion seeking this payment and that the filing of the motion was an “unnecessary and meaningless act.”

“The [d]ebtors in substance argue that because they did not pay, and their reorganization plan was confirmed before they paid, they do not have to pay,” the court said. “Equity does not applaud a Catch 22.” The court found that the rent due in the 60 days post-petition was immediately due and directed the bankruptcy court to enter a judgment accordingly. The court also found that the amount of rent due after the 60 days up until June 7 when the lease was rejected could be determined by hearing by the bankruptcy court if requested.

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