Chicago, Rock Island and Pacific R. Co., Matter of

• Decision Date: 14 January 1985
• Docket Number: No. 83-1848,83-1848
• Citation: 753 F.2d 56
• Parties: Bankr. L. Rep. P 70,202 In the Matter of CHICAGO, ROCK ISLAND AND PACIFIC RAILROAD COMPANY, Debtor. Appeal of FARMERS COOPERATIVE ELEVATOR, RAKE, IOWA.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 56

753 F.2d 56

Bankr. L. Rep. P 70,202

In the Matter of CHICAGO, ROCK ISLAND AND PACIFIC RAILROAD

COMPANY, Debtor.

Appeal of FARMERS COOPERATIVE ELEVATOR, RAKE, IOWA.

No. 83-1848.

United States Court of Appeals, Seventh Circuit.

Argued Nov. 15, 1983.

Decided Jan. 7, 1985.

As Amended Jan. 14, 1985.

Leo E. Fitzgibbons, Fitzgibbons Bros., Estherville, Iowa, for appellant.

Nicholas G. Manos, Williams, Manos, Rutstein, Goldfarb & Sharp, Ltd., Chicago, Ill., for appellee.

Before CUDAHY, Circuit Judge, PELL, Senior Circuit Judge ^* and PERRY, Senior District Judge. ^**

CUDAHY, Circuit Judge.

The lessee of real property formerly owned by a railroad in liquidation appeals from the refusal of a reorganization court, sitting in equity, to alter the rent demanded by the railroad's trustee. We reverse and remand.

For more than 100 years appellants, Farmers Cooperative Elevator ("Farmers"), leased property in Rake, Iowa, that was owned by the Chicago, Rock Island and Pacific Railroad Company (the "Rock Island"). With the approval of the Rock Island, Farmers built a grain elevator on the property and shipped grain by way of the railroad line. The cost to Farmers to build the elevator and to install equipment now at the site was 2.5 million dollars. In March 1975, the Rock Island filed a petition for reorganization in the Northern District of Illinois, under Section 77 of the Bankruptcy Act (formerly codified at 11 U.S.C. Sec. 205 (1970)). On January 25, 1980, after rejecting the Trustee's plan of reorganization, the court ordered the Trustee to cease all operations as a rail carrier and to liquidate the assets of the estate, including the grain elevator in Rake, Iowa.

Farmers' rental of the elevator property, since June 1978, had been under a lease with a perpetual term and a base rent of $100 per month. ¹ Either party could terminate the lease at will upon 30 days' notice. On October 19, 1982, after Farmers declined to purchase the property at the Trustee's asking price, the Trustee sent notice terminating the lease effective November 30, 1982, and setting a new rental rate of $6,000 per month. Farmers refused to pay the increased rent. The Trustee then advertised the Rake, Iowa, property for sale. Farmers entered the sole sealed bid, in the amount of $305,000, which the Trustee accepted on December 13, 1982. However, Farmers and the Trustee reached an impasse, in their subsequent discussions, over the validity of the Trustee's unilateral action in raising the rent by 5900%. The two parties agreed to allow the reorganization judge to determine the proper rent for the period between termination of the lease and Farmers' purchase of the property. On January 19, 1983, the judge approved the sale of the Rake, Iowa, property but deferred ruling on the validity of the interim rental rate. At a hearing on the issue on May 4, 1983, the judge ruled in favor of the Trustee. The judge stated: "[T]he improvement is owned by the Trustee, and it doesn't matter who placed it there. The land as improved is what the Trustee had to lease to [Farmers] and it is on the basis of the improved value that the rental can and may be set. Six thousand dollars seems high, but on the basis of the value of the property as improved it is not such as to trigger the intervention of an equity court." ² Farmers, which has remained in continuous possession of the property since termination of the lease, now appeals the judge's decision approving the increased rent. ³

Farmers simply argues that it is unfair to force it to pay rent based on a value that includes improvements that it provided. ⁴ In the district court, Farmers presented an affidavit indicating that the total value of the property in an unimproved state is $10,000; this is an amount approximately equal to the hold-over rent that the Trustee seeks. The Trustee admits that a rental increase from $100 to $6,000 is substantial, but contends that the new rate represents the fair rental value of a grain elevator. In his brief, the Trustee argues that "[t]he Trustee's methodology of upgrading the leases had produced the desired result for all parties in interest. The Trustee was able to market the properties for fair values and to break the 'log jam' of parties willing to negotiate seriously."

Under choice-of-law principles applicable in railroad reorganization, we look to the law of the state in which the real property is located to determine the applicable principles of property law. See In re Chicago, Milwaukee, St. Paul & Pacific Railroad, 654 F.2d 1218, 1221-23 (7th Cir.1981); In re Boston & Maine Corp., 596 F.2d 2, 7-8 (1st Cir.1979). The property of concern in this case is located in Rake, Iowa, therefore Iowa law provides the framework for our analysis.

The traditional principle that, upon annexation to the leasehold, permanent improvements become the property of the landlord does not generally apply in the face of contrary lease provisions. See discussion 3 J. Grimes, Commentaries on the Modern Law of Real Property by George Thompson Sec. 1141 (1980). ⁵ The lease in the instant case stated that Farmers would have ten days after termination to remove all of its real and personal property, including buildings, before such property would be forfeited to the landlord. ⁶ Under Iowa law, if the lease specifically authorizes a tenant to construct and remove improvements, the tenant retains title even to seemingly permanent improvements. For example, in Leslie Pontiac v. Novak, 202 N.W.2d 114, 117 (Iowa 1972), the lease provided that at termination the tenant could remove any "fixture affixed to the realty as real property" so long as the premises were restored to their original condition. At a cost of $6,000, the tenant constructed a steel building on a concrete base. The landlord brought an action, at the end of the lease term, to enjoin the tenant from taking the building. The Iowa Supreme Court held that the lease provision controlled, and that the tenant had a right to remove the building from the property. Other jurisdictions give similar controlling weight to such lease provisions. See e.g., Sutton v. Frost, 432 A.2d 1311, 1313 (Me.1981); Fenlon v. Jaffee, 553 S.W.2d 422, 429 (Tex.Civ.App.1977). As we have noted, the lease in this case provided that Farmers could remove any of its "real, personal, or mixed" property, within ten days after termination of the lease. Thus, Farmers had title to the building throughout the lease term. Cf. Wycoff v. Gavriloff Motors, Inc., 362 Mich. 582, 588, 107 N.W.2d 820, 824 (1961) (stating that where there is an agreement that buildings installed by the tenant can be removed at the end of a lease term, they can be removed during the lease term as well). The Trustee has conceded that Farmers owned all of the improvements while the lease was in effect.

As we have indicated, this appeal concerns the proper rental rate during the holdover period from November 30, 1982 to January 19, 1983. Because Farmers did not remove the elevator from the leasehold within ten days after the lease was terminated, the Trustee argues that the elevator became his property and he should be free to charge rent as if he had owned the improvements during the entire holdover period. We cannot agree. The Trustee does not dispute that he accepted Farmers' continued possession of the property until the sale was complete despite Farmers' failure to pay the holdover rent demanded by the Trustee. Under Iowa law, a tenant in possession of property with the assent of the landlord is presumed to be a tenant at will until proven otherwise. Iowa Code Ann. Sec. 562.4 (West Supp.1984). See Warren v. Yocum, 223 N.W.2d 258, 262 (Iowa 1974) (executory contract allowing vendee to take possession); Potter v. Henry Field Seed Co., 239 Iowa 920, 924, 930-31, 32 N.W.2d 385, 388, 391 (1948) (occupancy after expiration of written lease). Further, the terms of a holdover tenancy, after the expiration of a written lease, are rebuttably presumed to be the same as under the lease. Friedman v. Weeks, 190 Iowa 1083, 1087, 181 N.W. 390, 391 (1921). Unless the facts demonstrate otherwise, only those provisions that the parties explicitly agree to modify are affected. Id. In the instant case, the proper rental is the only condition of Farmers' tenancy that arguably changed during the holdover period, and that is the very issue that the parties agreed to submit to the bankruptcy court. On the other hand, the lease term allowing Farmers to remove its improvements remained in effect during the entire holdover period. See Marty v. Champlin Refining Co., 240 Iowa 325, 333, 36 N.W.2d 360, 364 (1949) (tenant's right to remove property, granted in an earlier lease that has expired, continues although an agreement to extend tenancy is silent on the point). ⁷ We conclude that Farmers retained title to the improvements during the holdover period and that the rental should be set on that basis.

The parties have not cited, and our research has not uncovered, any bankruptcy cases that discuss whether rental paid to a trustee should be based, when the tenant owns the improvements, on the improved or the unimproved value of the property. However, in various contexts in which tenants own or have constructed improvements, other courts, when called upon to determine the proper rent, have chosen the unimproved value. See Myers v. Cornelius, 262 S.C. 417, 421-23, 205 S.E.2d 180, 182 (1974) (declaratory judgment action to determine rental value under an option to extend the lease); Murray v. Odman, 1 Wash.2d 481, 487, 96 P.2d 489, 491 (1939). Accord: Giovinazzi v. Chandler, 418 F.2d 916, 917 (3d Cir.1969) (the measure of landlord's damages against the lessee, during the term of the lease, should not include the value of tenant's improvements). In a similar vein, after a sale of realty has been set aside, the rent assessed against a vendee surrendering possession is generally based on a value that excludes improvements...