Fin. of America LLC v. Mortg. Winddown LLC (In re Ditech Holding Corp.)
| Decision Date | 22 September 2022 |
| Docket Number | 21-CV-10038 (LAK),Chap. 11 19-10412 (JLG) |
| Parties | In re DITECH HOLDING CORPORATION, et at., Debtors, v. MORTGAGE WINDDOWN LLC, as plan administrator, Appellee. FINANCE OF AMERICA LLC, Appellant, |
| Court | U.S. District Court — Southern District of New York |
Appearances:
Peter S. Partee, Sr.
Robert A. Rich
Hunton Andrews Kurth LLP
Attorneys for Appellant
Ray C Schrock, P.C.
Richard W. Slack
Sunny Singh
Natasha S. Hwangpo
Weil, Gotshal & Manges LLP
Attorneys for Appellee
Appellant Finance of America Reverse LLC ("FoA") appeals from a decision of the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court") holding that FoA's approximately $14 million dollar administrative priority claim against Chapter 11 debtor Reverse Mortgage Solutions, Inc. ("RMS")'s for post-petition breaches of loan subservicing agreements was legally insufficient and reclassifying it as a general unsecured claim. FoA argues that the Bankruptcy Court misapplied New York contract law to fashion a new and erroneous bankruptcy rule which, inFoA's words, provides "that all claims sounding in contract are deemed to arise at the time the contract was entered, regardless of when the breach occurred."[1] Appellant Mortgage Winddown LLC, the Chapter 11 Plan Administrator ("Plan Administrator"), rejoins that the Bankruptcy Court properly applied well-settled bankruptcy principles in denying administrative priority and that this appeal raises no new issues of law.
Appellant FoA is a reverse mortgage lender that retained RMS, a mortgage servicing company, to subservice certain loans beginning in March 2011. Between March 2011 and October 2018, FoA and RMS entered into three concurrent mortgage subservicing agreements. Under each of those agreements, RMS collected and remitted mortgage payments for FoA in exchange for subservicing fees and other consideration.[2] The first agreement, dated March 18, 2011 (the "March 2011 Agreement"), expired by its original terms - inclusive of automatic renewals - on March 19, 2018. However, after the original term had expired but before RMS filed its Chapter 11 petition, the parties executed a series of seven successive extension agreements (the "Pre-petition Extensions"), the last of which extended the term of the March 2011 Agreement through March 31, 2019.
The second underlying subservicmg agreement, dated December 12, 2017 (the "December 2017 Agreement"), had an original term of one month but afforded FoA a monthly renewal option, which FoA exercised continuously through February 2019.
Similarly, the third and final agreement, dated October 4,2018 (the "October 2018 Agreement"), provided for a one-month term subject to FoA's monthly renewal option. FoA exercised that option through September 2019, when RMS's court-approved Chapter 11 Plan took effect.
On February 11, 2019 (the "Petition Date"), RMS and certain of its affiliates filed a voluntary Chapter 11 petition. The debtors thereafter remained in possession and control of RMS as debtors in possession pursuant to Sections 1107(a) and 1108 of the Bankruptcy Code.[3]Subsequent to the Petition Date, FoA and RMS entered into four additional extensions to the March 2011 Agreement (the "Post-petition Extension Agreements"),[4] the last of which expired on September 30, 2019, the effective date of debtors' Chapter 11 Plan (the "Plan Effective Date"). Pursuant to that Chapter 11 Plan, RMS and its business were sold to an unaffiliated third party, which did not assume any of the subservicing agreements with FoA.
On November 11, 2019, FoA filed a proof of claim seeking administrative expense priority for $375,832.07 plus other amounts to be determined in damages allegedly resulting from RMS's breaches of subservicing agreements between the Petition Date and the Plan Effective Date. FoA later revised the claim amount to $14 million plus other amounts to be determined. The Plan Administrator filed an objection on April 17, 2020, which the Bankruptcy Court granted on October 21,2021 after a sufficiency hearing. The Bankruptcy Court concluded that FoA failed to meet its burden of demonstrating a plausible ground for administrative expense priority under the Bankruptcy Code and thus reclassified FoA's claims as general unsecured claims. FoA filed a notice of appeal to this Court.
At a high level, this appeal presents a single question of law: in what circumstances, if any, will a post-petition breach of an executory contract give rise to administrative expense priority under Section 503(b) of the Bankruptcy Code? Broadly speaking, FoA contends that the Bankruptcy Court denied administrative priority based on two erroneous legal conclusions: that (1) FoA's claims arose pre-petition because none of the Post-petition Extensions were "new" agreements as a matter of New York contract law; and (2) in FoA's words, "claims under pre-petition contracts never give rise to administrative expense priority."[5] The Plan Administrator rejoins that "more than 30 years of Second Circuit law" supports the Bankruptcy Court's result[6]
On appeal, this Court reviews the Bankruptcy Court's findings of fact for clear error and conclusions of law de novo.[7] FoA appeals here from a Bankruptcy Court ruling on claim sufficiency which, as set out in the operative claims procedures order, employs the same legal standard applicable on a motion to dismiss under Federal Rule of Civil Procedure- 12(b)(6).[8] Like a plaintiff in a civil action, the claimant must plead facts sufficient to "state a claim to relief that is plausible on its face."[9] Accordingly, a claim is sufficient where the "pleaded factual content [, assuming its truth,] allows the court to draw the reasonable inference" that the estate is liable for what the claimant has asserted.[10] Bankruptcy claimants asserting priority claims bear the burden of alleging facts that, if established, would entitle them to priority.[11]
This Court is not the first to observe that "in no area of bankruptcy 'has the law become more psychedelic than in the one titled 'executory contracts.""[12] In this appeal, the psychedelic confusion arises at the intersection of two parts of the Bankruptcy Code: Section 365, which governs the classification of breach claims under rejected executory contracts, and Section 503, which governs administrative priority.
11 U.S.C.§ 365
Section 365 permits the trustee or debtor in possession to "-assume or reject any executory contract.. . of the debtor... at any time before confirmation of a plan."[13] Simply put, it enables the trustee or debtor in possession to maximize the value of the estate by availing itself of contracts that are profitable while abandoning those that are burdensome.[14] Although the Bankruptcy Code does not define the term "executory contract," the Second Circuit has stepped in to define it as a contract "on which some performance remains due to some extent on both sides."[15]The parties to this appeal agree that the underlying FoA-RMS subservicing agreements were executory contracts.
In the course of a Chapter 11 bankruptcy, the debtor's executory contracts may be assumed, rejected, or maintained in limbo pending a trustee or debtor in possession's decision to assume or reject, which generally can be made at any point prior to plan confirmation.[16] If the trustee or debtor in possession elects to assume an executory contract, that contract remains enforceable post-bankruptcy. Any executory contract not expressly assumed as of the Plan Effective Date is deemed rejected.[17]
Section 365 treats rejection as a breach by the debtor deemed to have occurred "immediately before the date of the filing of the petition."[18] Accordingly, a rejected executory contract often will yield pre-petition claims even where breach has been triggered by post-petition performance or events.[19] Through Section 502(g)(1), a "claim arising from the rejection, under Section 365 ... [,] of an executory contract... shall be allowed ... the same as if such claim had arisen before the date of the filing of the petition" -viz., as a general unsecured claim.[20] As the Bankruptcy Court pointed out, however, post-petition breaches of rejected executory contracts yield contingent pre-petition claims only where the risk of that future breach was within the "actual or presumed contemplation of the parties" at the time they entered the relevant contractual relationship.[21]
11 U.S.C.§ 503
Section 503(b) of the Bankruptcy Code provides that "[a]fter notice and a hearing, there shall be allowed, administrative expenses . . . including the actual, necessary costs and expenses of preserving the estate."[22] Administrative expenses "receive highest priority in corporate bankruptcy proceedings."[23] Congress created administrative priority to incentivize entities to "do business with the debtor in possession" so as to rehabilitate the business for the benefit of all creditors,[24] as well as to "fulfill[] the equitable principle of preventing unjust enrichment of the debtor's estate, rather than the compensation of the creditor for the loss to him."[25] To qualify for administrative priority, the expense must represent "a concrete, discernible benefit" to the estate; a "speculative benefit or the mere potential for benefit is not enough[.][26] Thus, as the Second Circuit has summarized, "an expense is administrative only if it arises out of a transaction between the creditor and bankrupt's trustee or debtor in possession ... and 'only to the extent that the consideration supporting the claimant's right to payment...
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