In re Merry-Go-Round Enterprises

• Decision Date: 15 October 1999
• Docket Number: Bankruptcy No. 94-5-0161-SD.
• Citation: 241 BR 124
• Parties: In re MERRY-GO-ROUND ENTERPRISES, et al., Debtors.
• Court: U.S. Bankruptcy Court — District of Maryland

241 B.R. 124 (1999)

In re MERRY-GO-ROUND ENTERPRISES, et al., Debtors.

Bankruptcy No. 94-5-0161-SD.

United States Bankruptcy Court, D. Maryland, Baltimore Division.

October 15, 1999.

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Cynthia L. Leppert, Neuberger, Quinn, Gielen, Rubin & Gibber, Baltimore, MD, for the trustee.

Stephen A. Bogorad, Philip T. Evans, Holland & Knight, Washington, DC, for The Equitable Life Assurance Society of the United States.

Billy G. Leonard, Jr., Strasburger & Price, Dallas, TX, for Sharpstown Center Associates.

Scott A. Semenek, Rudnick & Wolfe, Chicago, IL, for The Lake County Trust Company.

Kevin M. Newman, Menter, Rudin & Travelpriece, Syracuse, NY, for Carousel Center Company, LP.

Karen H. Moore, Assistant U.S. Trustee, Office of the U.S. Trustee, Baltimore, MD, for the U.S. Trustee.

CONCLUSIONS OF LAW IN ANTICIPATION OF AN EVIDENTIARY HEARING ON TRUSTEE'S TWELFTH OMNIBUS OBJECTION TO CLAIMS

E. STEPHEN DERBY, Bankruptcy Judge.

Before the court is the Twelfth Omnibus Objection to Claims (the "Objection") filed by the Chapter 7 Trustee ("Trustee"). In her Objection the Trustee argues that the claims of four landlords whose leases were assumed by the Debtor-In-Possession during the Chapter 11 phase of this case and subsequently rejected by the Trustee in Chapter 7 are not administrative expenses and are not calculated correctly. The landlords are: Sharpstown Center Associates (claim no. 6048) ("Sharpstown"); Equitable Life Assurance Co. (claim nos. 8149 and 8157)¹ ("Equitable"); Lake County Trust Co. (claim no. 6895) ("Lake County"); and Carousel Center Co. (claim no. 6957) ("Carousel") (collectively the "Landlords"). Each Landlord has responded to the Objection.

The Objection has been bifurcated at the request of the parties, and the court will address here only the governing legal issues. These legal issues are: (1) whether the Landlords' lease rejection claims are administrative expenses; (2) what are the Landlords' obligations as to mitigation of damages; and (3) whether lease rejection claims should be reduced to present value. Two additional legal issues woven through the first three are (a) what law applies; and (b) who bears the burden of proof at various points in the analysis. For reasons discussed below, the court concludes: (1) the Landlords' lease rejection claims are Chapter 11 administrative expenses; (2) the Landlords have a duty under the law of the state in which each property is located to mitigate the lease rejection damages; and (3) under applicable state law, lease rejection damage claims must be reduced to present value. On the issues of mitigation and damages, the burden of going forward and the burden of persuasion may alternate.

Background

Merry-Go-Round Enterprises, Inc. ("MGRE"), the Debtor and Debtor-In-Possession, was a retailer of young men and women's fashion clothing. MGRE was the lessee of approximately 1450 retail locations throughout the United States. MGRE filed a voluntary Chapter 11 bankruptcy petition in January, 1994. This court converted the case to Chapter 7 on March 1, 1996, after the reorganization effort failed. While the case was still in Chapter 11, MGRE assumed the five leases with these four landlords. After conversion, the Trustee rejected these five leases.

Discussion

A. The Landlords' lease rejection claims are Chapter 11 administrative expenses.

After the Objection was filed, the United States Court of Appeals for the Fourth Circuit entered its decision in In re Merry-Go-Round Enterprises, Inc., 180 F.3d 149 (4th Cir.1999), (affirming D.C.D.Md., which had affirmed 208 B.R. 637 (Bankr. D.Md.1997) ("Cutler Ridge")). Cutler Ridge involved claims of a landlord that had entered into a postpetition lease with MGRE, which the Trustee declared rejected after conversion. In concluding that the landlord's future rent claim was a Chapter 11 administrative expense, the court noted that "an assumed lease is functionally equivalent to a postpetition lease. . . ." Cutler Ridge, 180 F.3d at 156, 158. In reaching its decision the court relied heavily on In re Klein Sleep Products, Inc., 78 F.3d 18 (2nd Cir.1996), a case in which, as here, the debtor-in-possession had assumed a prepetition lease that the Chapter 7 trustee rejected post-conversion. As the Fourth Circuit stated:

We believe that this authority Klein Sleep and In re Lamparter Org., Inc., 207 B.R. 48 (E.D.N.Y.1997) is equally applicable in this case because the perfection of a new postpetition lease is analogous to the postpetition assumption of a prepetition lease in that the debtor-in-possession undergoes the same deliberative process when it enters into a new lease as when it assumes an old one. When considering whether or not to enter into a new lease, the debtor-in-possession examines a draft lease and determines whether or not it would be in the best interest of the estate. If the debtor-in-possession concludes that the new lease would be in its best interest, it seeks approval from the bankruptcy court. Likewise, when considering whether or not to assume an unexpired lease, the debtor-in-possession examines the unexpired lease and determines whether or not it would be in the best interest of the estate. If the debtor-in-possession concludes that the lease would be in its best interest, it assumes the unexpired lease and seeks approval from the bankruptcy court.

Cutler Ridge, 180 F.3d at 155 (emphasis added).

Because the Fourth Circuit found that assumed leases and new leases entered into postpetition are functionally analogous, this court must make the same inquiries in response to this Objection as were made by the Fourth Circuit in Cutler Ridge.

As with any other administrative claim, determining whether future rent is entitled to administrative priority is to be determined on a case-by-case basis. Cutler Ridge, 180 F.3d at 156. In making such a determination, the claimant "has the burden of proving that its administrative claim for future rent is an actual and necessary expense." Id. at 157. See also 11 U.S.C. § 503(b)(1)(A). Further,

For a claim to qualify as an actual and necessary administrative expense, "(1) the claim must arise out of post-petition transaction between the creditor and the debtor-in-possession (or trustee) and (2) the consideration supporting the claimant\'s right to payment must be supplied to and beneficial to the debtor-in-possession in the operation of the business."

Cutler Ridge, 180 F.3d at 157 (quoting In re Stewart Foods, Inc., 64 F.3d 141, 145 n. 2 (4th Cir.1995)).

"The test to determine actual expense is whether the claim arose out of a post-petition transaction between the landlord and MGRE." Cutler Ridge, 180 F.3d at 157. In Cutler Ridge the Fourth Circuit held that entering into a new lease postpetition was a postpetition transaction. See id. The Landlords' leases were assumed by MGRE postpetition, and "an assumed lease is functionally analogous to a postpetition lease. . . ." Id. at 156. Therefore, the assumption of each of the leases was a postpetition transaction between MGRE and the respective Landlord, and the leases were actual costs of preserving the estate.

"The test to determine necessary expense is whether the landlord's consideration supporting its right to payment was `supplied to and beneficial to' MGRE." Cutler Ridge, 180 F.3d at 157 (quoting Stewart, 64 F.3d at 145 n. 2). To make this determination the court must look at whether the leases were beneficial to the bankruptcy estate of MGRE both before and after conversion. See id. at 157.

The Trustee and the Landlords agree that the leases were beneficial to MGRE prior to conversion. Further, "assumed contracts do in fact constitute a post-bankruptcy benefit to the estate." Klein Sleep, 78 F.3d at 25. These assumed leases provided a benefit to MGRE, as debtor in possession, because the MGRE estate, in anticipation of a successful reorganization, gained the opportunity to use the premises for the remainder of the lease terms. This court allowed MGRE to assume the leases because it found that MGRE had used sound business judgment in determining that assuming each of the leases was in the best interest of the estate. See Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1046 (4th Cir.1985). The action of this court in approving MGRE's assumption of the leases precludes a subsequent finding that MGRE's assumption of the leases was not a benefit to MGRE. See Klein Sleep, 78 F.3d at 25. MGRE's assumption of these leases thus provided a pre-conversion benefit to MGRE, and this benefit in expectation extended to the full term of the assumed leases. The Landlords also benefited from the certainty of status and expectation of payment provided by MGRE's assumption.

In determining whether assumption of the leases provided a necessary post-conversion expense to the estate, the court must look at the assumption from both the Landlords' and the Trustee's perspectives. See Cutler Ridge, 180 F.3d at 157. When considering the landlord's position in Cutler Ridge, the Court of Appeals stated:

As far as the landlord, DeBartolo, is concerned, Chapter 7 conversion did not change the lease. Although conversion dramatically altered the character of MGRE, DeBartolo still expected MGRE to honor its lease agreement. If MGRE had been able to sell the lease to another party, DeBartolo would have continued to receive rent payments. Unfortunately, despite its best efforts, MGRE was unable to relet the premises.

180 F.3d at 157. The Landlords in this Objection expected the same benefits. When the leases were assumed by MGRE while it was seeking to reorganize under Chapter 11, the Landlords had an expectation that they would continue to be paid, and this expectation continued after conversion until the Trustee rejected the leases. Consequently, the leases provided the Landlords with an expected post-conversion benefit.

The Trustee also enjoyed...