In re Ames Dept. Stores, Inc., 01-42217 (REG).

• Decision Date: 26 February 2004
• Docket Number: No. 01-42217 (REG).,01-42217 (REG).
• Parties: In re AMES DEPARTMENT STORES, INC., et al., Debtors.
• Court: U.S. Bankruptcy Court — Southern District of New York

306 B.R. 43

In re AMES DEPARTMENT STORES, INC., et al., Debtors.

No. 01-42217 (REG).

United States Bankruptcy Court, S.D. New York.

February 26, 2004.

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Weil, Gotshal & Manges, LLP, by Martin J. Bienenstock, Esq., Michele J. Meises, Esq., Timothy Q. Karcher, Esq. (argued), New York City, for the Debtors and Debtors in Possession.

Otterbourg, Steindler, Houston & Rosen, P.C., by Scott L. Hazan, Esq., Rosanne Finkel, Esq. (argued), New York City, for the Official Committee of Unsecured Creditors.

Law Offices of Leo Fox, by Leo Fox, Esq. (argued), New York City, for DSM Realty Inc. and Valley Properties.

DECISION ON MOTIONS FOR PAYMENT OF REAL ESTATE OCCUPANCY ADMINISTRATIVE EXPENSES (D.S.M. REALTY, INC. AND VALLEY PROPERTIES, INC.)

ROBERT E. GERBER, Bankruptcy Judge.

In this contested matter in the jointly administered chapter 11 cases of Ames Department Stores and its subsidiaries ("Ames," or the "Debtors"), the Court has before it motions for payment, with administrative expense priority over the claims of other creditors, by landlords D.S.M. Realty, Inc. and Valley Properties, Inc. (the "Landlords"), whose leases ("Leases") for retail space previously used by Ames have now been rejected. The requests present five separate issues, several of which are recurring ones in chapter 11 cases in this district and elsewhere.

The first two involve (1) whether a debtor-tenant's lease can be rejected when, contrary to a cleanup obligation in its lease, it leaves behind, on the premises, abandoned personal property that assertedly results in a continued occupancy of the premises on the part of the tenant, and (2) whether unsatisfied cleanup obligations under rejected leases give rise to post-petition obligations, under sections 503(b) or 365(d)(3) of the Code, or instead give rise to pre-petition rejection claims.

The third arises from Ames' rejection of the leases in mid-month, after rent was due at the beginning of the month. The Landlords assert that because the Leases required monthly rent to be paid in advance on the first of the month, the rental payment for the full month must now be paid in full, even though the Debtors lost their right to occupancy upon their mid-month rejection. Ames and its non-landlord creditors counter that requiring payment in full would grant a windfall to the Landlords, and that monthly rent should instead be prorated through the rejection date.¹

The fourth is unique to this case, in which Ames is faced with the risk of administrative insolvency, and in which Ames, the Landlords and a DIP financing lender, Kimco Funding, LLC ("Kimco"), entered into a stipulation to resolve objections by the Landlords to a then-pending motion (the "Objections Withdrawal Stipulation"), which may have changed the rights that parties otherwise might have when a debtor is administratively insolvent. The Landlords acknowledge the law in this Circuit, and in the bulk of the courts elsewhere, that expenses payable under Bankruptcy Code section 365(d)(3) have administrative priority but not an implied super-priority, and thus, when an estate is administratively insolvent, unpaid section 365(d)(3) claims share pari passu with other unpaid administrative expenses. But the Landlords contend that this general rule is trumped under the unique facts here, where the Objections Withdrawal Stipulation, so-ordered by the Court, provided that Kimco would fund post-petition rent until the lease in question was rejected.

Fifth, and finally, the Court must determine the extent to which one Landlord's section 365(d)(3) entitlement properly includes claims for its attorneys' fees.

Applying the law to the facts here, the Court determines:

(1) Ames' compliance with its cleanup obligations was not a condition precedent to its exercise of its statutory right to reject leases;

(2) At least under the facts here, Ames' failure to comply with its contractual duties to clean up the premises upon the termination of the lease, when such took place after rejection, gave rise to a pre-petition claim for breach of the lease, and not a post-petition breach — and did not, by itself, make Ames a holdover tenant liable for continued rent or other liability after the time of its rejection;

(3) As claim for 365(d)(3) payment here was made after rejection (and not when the debtor was continuing in occupancy), Ames's liability under section 365(d)(3) is limited to the pro-rata accrual for its occupancy obligations in the post-petition, pre-rejection period. Ames is not now liable for obligations relating to the time after the debtor-tenant's rejection — though if timely request had been made by the landlord for payment in full of section 365(d)(3) obligations while the debtor-tenant was still in occupancy, this Court would have required payment by the debtor in full, subject to disgorgement in the event of subsequent rejection and any resulting overpayment to the landlord;

(4) The Landlords are entitled to payment by Kimco, under the terms of the Objections Withdrawal Stipulation, of the post-petition rent that Kimco agreed to fund; and

(5) Valley is entitled to reasonable attorneys fees, as authorized under its lease, as part of Ames' section 365(d)(3) obligations.

Facts

The material facts were undisputed, and the Court thus had no need for an evidentiary hearing.

Until it became clear, in the course of its chapter 11 case, that Ames could not successfully reorganize as an ongoing business and would have to liquidate, Ames was a discount retailer, operating hundreds of stores in leased premises. Its store leases — a large number of which were executed years ago, in environments of lower rental rates — in many cases had substantial value, and an important aspect of the Ames chapter 11 case has been the array of real estate decisions to be made concerning the stores and store leases, particularly with respect to whether leases could be sold by "assume-and-assign" transactions, or instead would be rejected.

In at least most cases, Ames explored marketing particular leases, and decided to reject leases only after coming to a view that marketing efforts would be unsuccessful or not cost-effective. To facilitate its marketing efforts, Ames secured DIP financing from Kimco, secured by its leases — or, perhaps more precisely, the proceeds of "assume-and-assign" sale transactions with respect to those leases. An objection by certain landlords (including D.S.M. and Valley) to the Kimco DIP financing motion was consensually resolved by the Objections Withdrawal Stipulation, so-ordered by the Court the next day. It provided, in relevant part:

1. The objection filed by the Landlords to the Motion for an order approving the Kimco DIP Loan is hereby withdrawn subject to the terms and conditions set forth below.

...

3. Each Landlord's rights, if any, under the lease and applicable law to seek to lift the automatic stay, to compel payment of post-petition rent[,] to compel compliance with an existing confidential agreement with the Debtors, or to seek an earlier time for the assumption or rejection of their lease, are all reserved (as are the rights of Kimco and the Debtors to oppose such motions).

...

6. In the event any of the Landlord's leases are rejected or excluded after the Kimco Credit Agreement becomes effective, Kimco shall fund the post-petition rent until the earlier of (i) the effective date of rejection or (ii) thirty (30) days after such lease is excluded under the Kimco Credit Agreement.²

In connection with the marketing efforts, the Court approved expedited rejection procedures for any leases the Debtors were unable to sell.³ Pursuant to those procedures, Ames sought to reject the two leases at issue here. On March 20, 2003, the Debtors served a rejection notice on D.S.M., indicating that, unless an objection was received by the Debtors within ten days thereafter, the lease governing D.S.M.'s store would be rejected as of that day, and personal property located at the premises would be abandoned. On April 4, 2003, Ames served a rejection notice on Valley, likewise indicating that, unless an objection was received within ten days thereafter, the lease governing Valley's store would be rejected as of April 4, 2003 and personal property located at the premises would be abandoned.

Ames vacated the premises and returned the keys to the properties on March 20, 2003 and April 4, 2003, respectively. As of the time it did so, Ames had not paid the rent that came due on each lease on the first day of the month in which each store was vacated. Additionally, Ames abandoned personal property on the premises (principally shelving, racks, bins and similar trade fixtures) that had to be removed and/or cleaned up, at somebody's expense — even though each lease required that at the termination of the lease, the premises were to be left by the tenant clean and/or free of goods and effects.⁴

However, there was no showing here that the Debtors intentionally damaged the premises; committed any other kind of post-petition tort with respect to the premises; or placed hazardous materials on the premises that might endanger public health or safety. Rather, the issue here was solely one of the burden and expense of removing non-hazardous personal property that was appropriately on the premises during the time before rejection. As the Landlords put it:

It is believed that the Debtor, during its liquidation sale, sold any asset in the Premises of value. As such, the only personal property left on the Premises would have little to no value and would cost substantially more to remove tha[n] it would yield at any sale.⁵

The Landlords filed timely objections to the two rejection notices. They contended principally (1) that the leases could not be rejected unless and until the premises were left in clean condition, as required under the Leases; (2) that unpaid...