Federal's Inc. v. Edmonton Inv. Co.

• Decision Date: 11 April 1977
• Docket Number: No. 76-1249,76-1249
• Citation: 555 F.2d 577
• Parties: FEDERAL'S, INC., Plaintiff-Appellant, v. EDMONTON INVESTMENT CO., Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 577

555 F.2d 577

FEDERAL'S, INC., Plaintiff-Appellant, v. EDMONTON INVESTMENT CO., Defendant-Appellee.

No. 76-1249.

United States Court of Appeals Sixth Circuit.

Argued Feb. 14, 1977.

Decided April 11, 1977.

Sheldon S. Toll, Honigman, Miller, Schwartz & Cohn, Detroit, Mich., for plaintiff-appellant.

Lewis Daniels, Lewis Daniels and James M. Wienner, Detroit, Mich., for defendant-appellee.

Before WEICK and LIVELY, Circuit Judges, and TAYLOR, ^* District Judge.

ROBERT L. TAYLOR, District Judge.

Federal's, Inc. (Federal's), the debtor in a Chapter XI bankruptcy proceeding, perfected this appeal from a decision of the district court affirming a bankruptcy court decision. Federal's, Inc. v. Edmonton Investment Company, 404 F.Supp. 68 (E.D.Mich.1975). The bankruptcy judge dismissed Federal's petition to determine that its liability to Edmonton Investment Company (Edmonton) under a real property lease had been discharged upon confirmation of an arrangement plan, and denied Federal's petition under Bankruptcy Rule 924 and Rule 60 of the Federal Rules of Civil Procedure to modify the confirmation order to permit Federal's to reject the lease.

The facts were stipulated in the proceeding below. On January 11, 1971, Edmonton, as the lessor, entered into a twenty-year lease agreement with Federal's as the lessee. The lease covered certain real property and called for monthly rental payments of $11,288.98 plus taxes and interest. The lease provided that Federal's had the right to assign its rights under the lease, but an assignment, if made without the prior written consent of Edmonton, failed to relieve Federal's of its continuing liability for the performance of its obligations under the lease.

Federal's assigned the lease to one of its subsidiaries, Federal Hardware and Supply, Inc. (Federal Hardware), on June 24, 1972, without the prior written consent of Edmonton. Approximately three weeks later, Federal's filed a petition under Chapter XI of the Bankruptcy Act, 11 U.S.C. § 701 et seq. (hereinafter "the Act"), and a receiver was appointed. The terms of the lease provided that the filing of a petition for an arrangement was an event of default. Although this default entitled Edmonton to terminate the lease, it chose not to exercise such option at that time. ¹

Beginning on February 21, 1973, all notices to creditors in the arrangement proceedings were sent to Edmonton. In those proceedings, Federal's scheduled Edmonton as a lessor of an assigned lease to whom it was "contingently" liable for the amount of $10.00. Apparently such listing was the result of Federal's belief that because the assignee was paying the rents promptly, at that time, its liability as an assignor was only "contingent."

On October 1, 1973, the assignee, Federal Hardware, defaulted on the lease and Edmonton promptly sent Federal's a written notice of default. Some two months after Federal Hardware's default, the arrangement plan was confirmed by the bankruptcy judge. The Edmonton lease was not rejected in the confirmed plan, although the plan provided for the rejection of many other leases of real property. Edmonton made no attempt during the arrangement proceedings to file a claim against Federal's based on the lease, but on May 6, 1974 Edmonton filed suit in state court to recover from Federal's all unpaid rents which had accrued since the date of confirmation. ²

Federal's then petitioned the bankruptcy court for a determination that the unpaid rents allegedly due Edmonton had been discharged by virtue of Edmonton's failure to file a timely claim in the Chapter XI proceedings. The bankruptcy judge dismissed this petition on August 14, 1974, and three months later Federal's petitioned the bankruptcy court to modify the confirmation order so as to permit a rejection of the Edmonton lease. This petition was also denied by the bankruptcy judge and both denials were affirmed by the district court. Federal's challenges on appeal the denial of both of those petitions, and seeks to reverse either ruling and thereby defeat liability for unpaid rents due under the lease. ³

I.

The district court held that Federal's obligation to Edmonton under the lease was not discharged by confirmation of the plan of arrangement because the lease was an executory contract which Federal's failed to reject. A confirmed arrangement plan generally discharges any debt or liability owed to a scheduled creditor, unless such debt or liability is provided for in the plan. 11 U.S.C. § 771. Executory contracts and the debtor's obligation thereunder, however, are not discharged by a Chapter XI arrangement plan and remain in effect unless the debtor affirmatively rejects them during the Chapter XI proceedings. See, e.g., Smith v. Hill, 317 F.2d 539 (9th Cir.1963). As observed by the district court, this rule is consistent with the purpose of Chapter XI of enabling debtors to continue their business under court supervision. 404 F.Supp. at 71, citing SEC v. American Trailer Rentals, 379 U.S. 594, 606-07, 85 S.Ct. 513, 13 L.Ed.2d 510 (1965).

Rejection may be permitted by the bankruptcy court upon notice to the appropriate parties, or it may be provided for in the plan submitted for confirmation. 11 U.S.C. §§ 713(1) and 757(2). Thus, the debtor must take affirmative action to reject an executory contract.

"The failure to assume affirmatively an executory contract does not result at any time in the rejection of the contract. Whether the debtor is in possession, or whether there is a receiver or trustee, the contract can be rejected only by affirmative action under § 313(1) and Chapter XI Rule 11-53 or § 357(2). Unless so rejected, the contract continues in effect." (footnote omitted) (emphasis added)

8 Collier on Bankruptcy P 3.15(6) (14th ed. 1976).

The district court approved the bankruptcy judge's finding that Federal's failed to affirmatively reject the Edmonton lease, and Federal's has not challenged this determination on appeal.

Federal's contends, however, that the district court erred by holding that the lease was an executory contract because the assignment converted the lease from an executory contract to a suretyship agreement, which is not an executory contract.

It is clear that an unexpired lease of real property is considered an executory contract under Chapter XI. The relevant section of Chapter XI provides in pertinent part:

"(Meaning of terms used). For the purposes of this chapter, unless inconsistent with the context

"(4) 'executory contracts' shall include unexpired leases of real property . . .." 11 U.S.C. § 706(4).

Relying on this provision, the district court concluded that the rule advanced by Federal's that a suretyship or guaranty agreement is not an executory contract was not relevant to the outcome of this case, and observed that:

"Federal's is primarily liable on the lease, being the only contracting party with Edmonton on that lease. That primary liability does not cease because it sublets the premises and assigns the lease to a third person. Federal's continues in such a case to be the primary obligor on the contract. The lease by Edmonton to Federal's was an executory contract under the Bankruptcy Act. 11 U.S.C. 706(4). All leases of real property, whether assigned by subletting or unassigned, are and continue to be executory contracts between the lessor and original lessee." 404 F.Supp. 73-4.

Indeed, by the express terms of the lease, Federal's remained primarily liable by virtue of its making an unapproved assignment.

Federal's relies on three cases decided by the Second Circuit Court of Appeals, In re Radio-Keith-Orpheum Corp., 91 F.2d 1004 (2d Cir.), cert. denied, Irving Trust Co. v. Burnett, 302 U.S. 754, 58 S.Ct. 282, 82 L.Ed. 583 (1937), In re Paramount Publix Corp., 85 F.2d 83 (2d Cir.1936), and T.A.D. Jones Co. v. Winchester Repeating Arms Co., 55 F.2d 944 (D.Conn.), aff'd, 61 F.2d 774 (2d Cir.1932), cert. denied, Southeastern Investment Co. of Savannah, Ga. v. Tobler, 288 U.S. 609, 53 S.Ct. 401, 77 L.Ed. 983 (1933), in support of the position that, upon assignment of the lease, Federal's became a surety for the performance of its assignee and was no longer a party to an executory contract. We are of the opinion that the holdings of these cases are inapposite to the facts of the present case, and do not require a result different from that reached by the district court.

In re Radio-Keith-Orpheum Corp., supra, involved an arrangement under former Section 77B of the Act. The Court considered the relation of a sublessor to its sublessee, and did not consider a lessee-assignor's obligation similar to Federal's herein. A sublessor's obligation to its original lessor is significantly different from that of a lessee-assignor to its original lessor.

The Court in In re Paramount Publix Corp., supra, also an arrangement proceeding under former Section 77B of the Act, applied Ohio law to determine whether certain acts on the part of the lessor constituted a termination of the lease. Ohio law was also interpreted by the Court as placing the assignor in the status of a surety for its assignee's liability to the original lessor. Ohio law is not controlling in our case, and Federal's has failed to cite any Michigan authorities for its position. Moreover, there is no indication in that case that the lease contained a clause expressly providing for continuing liability on the part of the lessor in the event of an unconsented assignment.

The third case referred to by Federal's, T.A.D. Jones Co. v. Winchester Repeating Arms Co., supra, involved a receivership in equity. The Court dealt specifically with a lessee's relationship to the original lessor after an assignment of the lease by the lessee. The Court noted that the privity of estate between the lessee-assignor and the lessor was broken by the assignment because the assignee came into privity of estate with the lessor. The assignee also expressly assumed all the covenants of the ...