In re Bankvest Capital Corp.

• Decision Date: 15 March 2004
• Docket Number: No. 03-9006.,03-9006.
• Citation: 360 F.3d 291
• Parties: In re BANKVEST CAPITAL CORP., Debtor. Eagle Insurance Company and Newark Insurance Company, Appellants, v. Bankvest Capital Corp., Appellee.
• Court: U.S. Court of Appeals — First Circuit

360 F.3d 291

In re BANKVEST CAPITAL CORP., Debtor Eagle Insurance Company and Newark Insurance Company, Appellants, v. Bankvest Capital Corp., Appellee.

No. 03-9006.

United States Court of Appeals, First Circuit.

Heard January 5, 2004.

Decided March 15, 2004.

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Joseph S.U. Bodoff, with whom Richard P. O'Neil and Bodoff & Slavitt LLP were on brief, for appellants.

Jay L. Gottlieb, with whom Arianna Frankl, Brown Raysman Millstein Felder & Steiner LLP, Frederic D. Grant, Jr., and Grant & Roddy were on brief, for appellee.

Before LYNCH, Circuit Judge, CAMPBELL, Senior Circuit Judge, and LIPEZ, Circuit Judge.

LYNCH, Circuit Judge.

This case presents a narrow but important question of statutory interpretation under the Bankruptcy Code: whether 11 U.S.C. § 365(b)(2)(D) permits the debtor-in-possession to assume an unexpired lease without first curing non-monetary defaults. The Ninth Circuit, in the only court of appeals opinion to address this question, held that non-monetary defaults must be cured before assumption. In re Claremont Acquisition Corp., 113 F.3d 1029, 1034-35 (9th Cir.1997). In the proceedings below, the bankruptcy court and the Bankruptcy Appellate Panel (BAP) reached the opposite conclusion. We disagree with the Ninth Circuit and affirm.

I.

For purposes of this appeal, we accept the facts as alleged by appellants.¹ BankVest Capital Corporation, the debtor and appellee in this action, was in the business of originating, securitizing, selling, and servicing equipment leases. On May 27, 1999, appellants Eagle Insurance Company and Newark Insurance Company entered into separate but substantially similar lease agreements with BankVest.² BankVest agreed to lease 190 specified items of computer equipment to each of the appellants for a term of 48 months. Under the leases, Eagle and Newark were obligated to make monthly rental payments of $10,111.82 and $11,940.61, respectively. BankVest agreed to arrange for delivery of the equipment directly from Nortel, the manufacturer.

Eagle and Newark were aware, however, that Nortel would not complete production of twenty of the 190 items until several months after the start of the lease term. Those twenty items, Eagle and Newark say, collectively accounted for 60% of the entire value of the leased goods and constituted the most critical pieces of equipment. Accordingly, it was agreed that Nortel would provide appellants with substitute "loaner" equipment until those twenty items were completed and delivered.³ Nortel delivered the leased equipment, including the substitute items, in August 1999. On August 25, Eagle and Newark executed certificates of acceptance acknowledging their receipt of the leased equipment in operating condition.⁴

On December 17, 1999, before the loaner equipment could be replaced, an involuntary Chapter 11 petition was filed against BankVest in the United States Bankruptcy Court for the District of Massachusetts. BankVest did not contest the petition, and the bankruptcy court entered an order for relief on January 25, 2000. Once in bankruptcy, BankVest proposed a plan of reorganization that contemplated a gradual liquidation of its assets. After several revisions, the bankruptcy court confirmed the plan on May 31, 2001. Meanwhile, Eagle and Newark continued to use the leased computer equipment but paid no rent to BankVest, accumulating a collective arrears of approximately $1 million. That debt remains unpaid.

This appeal arises out of the provisions in BankVest's confirmed Chapter 11 plan that govern the assumption of BankVest's unexpired equipment leases. The plan provides that every equipment lease in which BankVest is the lessor shall be deemed assumed by the estate under 11 U.S.C. § 365 unless (1) the lease is specifically rejected or (2) any party to the lease files a claim for cure costs. In the event a claim for cure costs is made, the plan permits BankVest to defer its decision whether to assume or reject the lease until the bankruptcy court determines the amount of the cure costs, if any, that the estate would be obligated to pay upon assumption.⁵ See 11 U.S.C. § 365(b)(1).

On June 15, 2001, Newark and Eagle filed timely claims for cure costs under this procedure. They charged that BankVest had defaulted on the leases by failing to replace the loaner equipment with the final twenty items from Nortel.⁶ Further, they contended that this nonmonetary default was an historical fact not susceptible to cure (i.e., nothing BankVest could do would remedy its historical failure to deliver the equipment on time). In the alternative, Newark and Eagle argued that if the estate were allowed to cure, they would each be entitled to damages in excess of $300,000, as well as reductions in the rent payments owed to BankVest. Finova Loan Administration, Inc., filed an objection to appellants' cure claims on behalf of the estate on August 15, 2001.⁷

Treating Finova's objection as a motion to dismiss, the bankruptcy court held a non-evidentiary hearing on November 7, 2001. On December 11, 2001, the court dismissed appellants' cure claims on a ground not raised by either party: that 11 U.S.C. § 365(b)(2)(D) permits the debtor-in-possession⁸ to assume an executory contract or unexpired lease without first curing non-monetary defaults. In re BankVest Capital Corp., 270 B.R. 541, 543 (Bankr.D.Mass.2001). Because BankVest was not in default on any monetary provision — indeed, all of the payments under the leases flowed to BankVest, not from it — the court held that there were no cure claims that had to be satisfied before assumption. Id. at 544. The BAP affirmed on the same ground. In re BankVest Capital Corp., 290 B.R. 443, 447-48 (B.A.P. 1st Cir.2003). Eagle and Newark timely appealed.

II.

This court has jurisdiction over appeals from the BAP under 28 U.S.C. § 158(d). We review the bankruptcy court's conclusions of law de novo, with the benefit of the BAP's bankruptcy expertise but without deference to its conclusions. Fed. R. Bankr.P. 7052; In re Werthen, 329 F.3d 269, 272 (1st Cir.2003).

A. Legal Background

The dispute in this case concerns what is, in effect, an exception to an exception to the usual rule under 11 U.S.C. § 365. Section 365 generally allows the trustee in bankruptcy — or, as in this case, the debtor-in-possession — to assume or reject any pre-petition executory contract or unexpired lease, subject to the approval of the bankruptcy court. § 365(a); In re FBI Distrib. Corp., 330 F.3d 36, 42 (1st Cir.2003). This is one of the basic reorganizational tools available to debtors under the Bankruptcy Code. "[T]he authority to reject an executory contract is vital to the basic purpose [of] a Chapter 11 reorganization, because [it] can release the debtor's estate from burdensome obligations that can impede a successful reorganization." NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984). Under the Code, a rejected contract is considered to have been in breach prior to the bankruptcy petition, leaving the nondebtor party to the contract with a general unsecured claim for contract damages. 11 U.S.C. §§ 365(g)(1), 502(g); FBI Distrib., 330 F.3d at 42. If the debtor assumes a contract, however, it accepts both the burdens and the benefits of the bargain, and any liabilities incurred in the contract's postpetition performance will be treated as administrative expenses with priority status. See 11 U.S.C. § 507(a)(1) (priority for administrative expenses); FBI Distrib., 330 F.3d at 45. By permitting debtors to shed disadvantageous contracts but keep beneficial ones, § 365 advances one of the core purposes of the Bankruptcy Code: "to give worthy debtors a fresh start." In re Carp, 340 F.3d 15, 25 (1st Cir.2003).

There are, however, a variety of restrictions on the debtor's power to assume executory contracts and unexpired leases. Most relevant to this case is § 365(b), which provides that if the debtor has defaulted on a contract prior to assumption, the debtor cannot assume that contract unless it (1) cures the default; (2) compensates the nondebtor party for any actual pecuniary losses resulting from the default; and (3) provides adequate assurance of future performance under the contract.⁹ § 365(b)(1). Like the bankruptcy court, we will assume arguendo that BankVest's failure to replace the loaner equipment constituted such a default.

Yet the requirement in § 365(b)(1) that the debtor cure defaults prior to assumption itself has exceptions. Section § 365(b)(2) provides:

(2) Paragraph (1) of this subsection does not apply to 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 nonmonetary obligations under the executory contract or unexpired lease.

The bankruptcy court held, and the parties do not dispute, that BankVest's failure to deliver certain equipment is a "quintessential example of a nonmonetary default" within the meaning of subparagraph (2)(D). 270 B.R. at 544. The question on appeal is whether subparagraph (2)(D) excuses BankVest from the obligation that it otherwise bears under paragraph (1) to cure that default before assumption.

B. Interpretation of § 365(b)(2)(D)

(1) Plain text

As in any statutory interpretation case, we start with the text of the statute. In re Hart, 328 F.3d 45, 48 (1st Cir.2003). The language of § 365(b)(2)(D) can plausibly be interpreted in at least two ways. Eagle and Newark argue that the word "penalty" in subparagraph (2)(D) describes both "rate" and "provision." On their reading, Congress intended that subparagraph to read like this:

(D) the satisfaction of any penalty rate[, or any penalty provision] relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease.

This is essentially the interpretation that the...