In re Spoverlook, LLC

• Decision Date: 07 October 2016
• Docket Number: Case No. 15–13018 t11
• Citation: 560 B.R. 358
• Parties: In re: Spoverlook, LLC, Debtor.
• Court: U.S. Bankruptcy Court — District of New Mexico

560 B.R. 358

In re: Spoverlook, LLC, Debtor.

Case No. 15–13018 t11

United States Bankruptcy Court, D. New Mexico.

Signed October 7, 2016

James T. Burns, Albuquerque Business Law, P.C., Albuquerque, NM, for Debtor.

OPINION

Hon. David T. Thuma, United States Bankruptcy Judge

Before the Court is Debtor's motion to reject a state court settlement agreement with a homeowner's association. The Court previously found the settlement agreement was an executory contract. The homeowner's association resists rejection, arguing that it can obtain specific performance of the agreement, rejection would improperly contravene a state court order, and the proposed rejection is in bad faith. The Court disagrees and will grant Debtor's motion.

I. FACTS

The Court finds:

Debtor is the developer of a 260–acre residential development called San Pedro Overlook (the "Subdivision") in the "East Mountains" area northeast of Albuquerque. Debtor has completed the first of three phases (Phase I), which consists of about 50 residential lots, a community center, and a gatehouse. The Subdivision was built on a large plot of open space in a manner that maintains the character of New Mexico's natural surroundings.

The Subdivision is near another high-end development called San Pedro Creeks ("SPC"). SPC currently is the only development that can be seen from the Subdivision. There is a large open space between the Subdivision and SPC, which includes a certain parcel of undeveloped property called "Tract D." A portion of Tract D abuts a highway.

Around 2003, buyers started purchasing and building on the residential lots in Phase I. The properties were primarily marketed by Campbell Ranch Realty, an affiliate of the Debtor. Debtor advertised that the Subdivision is adjacent to 625 acres of open space. It is unclear whether that open space includes Tract D.

By 2013, Debtor had sold all of its residential lots in Phase I. Pursuant to the restrictive covenants encumbering the Subdivision,¹ Debtor was obligated to cede control of the Subdivision to the San Pedro Overlook Community Association (the "HOA") and to convey certain common areas to the HOA.

Debtor did not timely perform these obligations, possibly because it could not afford the required inspections and repairs. Debtor's development plans were severely affected by the "great recession" of 2008. Throughout 2013, the HOA demanded that Debtor perform its transition obligations.

In 2014, the HOA sued Debtor in New Mexico's Thirteenth Judicial District Court, commencing an action styled San Pedro Overlook Community Association v. SP Overlook, LLC , cause no. D–1329–CV–2014–01119. The suit sought to compel Debtor to, inter alia, convey the common areas to the HOA.

On March 30, 2015, the HOA and the Debtor signed a settlement agreement, under which Debtor agreed to convey the common areas to the HOA by April 30, 2015, in exchange for a mutual release of claims. Each party also agreed to pay a certain portion of property taxes and to submit a stipulated order dismissing the lawsuit.

Debtor and the HOA thought they had settled their differences. It turned out, however, that a dispute remained concerning Tract D. Paragraph 2 of the agreement defines "common areas" as the areas identified in the Declaration. It is not clear Tract D comes within this definition. Paragraph 2 goes on to state, however, that "the parties agree that the real property described in Exhibit A to this Agreement constitutes the common areas to be conveyed by [Debtor] in accordance with this [paragraph] 2...." The description in Exhibit A includes Tract D.

Debtor maintains that Tract D is not and has never been part of the common areas, and that Debtor never intended to convey Tract D to the HOA. Accordingly, Debtor argues the settlement agreement is ambiguous, and/or that a mistake was made. The HOA, in contrast, argues that the agreement unambiguously obligates Debtor to convey Tract D to the HOA.

The disposition of Tract D is important to the parties. Debtor wants to realize the value of Tract D so it can begin development on Phases II and III of the Subdivision. The HOA opposes any development of Tract D, and contends the Debtor represented that Tract D would remain undeveloped open space.

On July 22, 2015, the HOA filed a motion in state court to enforce the settlement agreement. The court held a short hearing on October 27, 2015. No witnesses testified, nor were any exhibits introduced into evidence. The hearing took about 33 minutes. The state court ruled for the HOA, stating:

I have reviewed this at some length, and I find that the settlement agreement is unambiguous, and should be ... enforced specifically by the Court. So the Court will decree that the defendant specifically perform and sign the deed. The issue concerning the tract—whichever one. ... I think the special warranty deed form is appropriate, in light of the fact that it calls out any and all easements of record. So the Court will order that defendant perform as indicated by the Court.

The parties agreed to submit an order memorializing the ruling within seven days. Counsel for the HOA prepared a form of order, but Debtor's counsel did not respond. On November 18, 2015, before the order was entered, Debtor filed this bankruptcy case. On the petition date, Debtor had not conveyed any property to the HOA, the HOA had not released any claims against the Debtor, and neither party had taken action to dismiss the lawsuit. At this Court's insistence, Debtor has since conveyed to the HOA all of the undisputed common areas, leaving only the disputed Tract D.

Debtor's interest in Tract D is its main asset. Debtor scheduled Tract D at $300,000; a lawsuit against Sonida, LLC at $250,000; and a potential malpractice suit against the lawyers who drafted the settlement agreement at $250,000. The value of the lawsuits is highly speculative. Sonida, LLC dissolved, and the malpractice suit may depend on, inter alia, the ultimate disposition of Tract D.

Debtor is not operating currently. Rejecting the settlement agreement and pursuing Tract D may be Debtor's main chance to reorganize.

By a memorandum opinion and order entered June 14, 2016, this Court determined the settlement agreement was an executory contract.

II. DISCUSSION

A. Rejecting Executory Contracts.

A debtor-in-possession may assume or reject executory contracts, subject to bankruptcy court approval. 11 U.S.C. § 365(a).² The business judgment test determines whether the Court should approve a proposed assumption or rejection. In re Tilco, Inc. , 558 F.2d 1369, 1373 (10th Cir. 1977) ; N.L.R.B. v. Bildisco and Bildisco, 465 U.S. 513, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984) (business judgment test applies to authorize rejection of an ordinary executory contract); In re Western Wood Products, Inc., 2013 WL 1386285, *21 (Bankr. D.N.M.) (citing Tilco and applying the business judgment test).

The test is not particularly strict. In re Mile Hi Metal Systems, Inc., 899 F.2d 887, 896 n. 13 (10th Cir. 1990) ("We do not consider the ‘business judgment test’ to be a strict standard to meet.") (quoting In re W. & L. Assoc., Inc. , 71 B.R. 962, 966 (Bankr. E.D. Pa. 1987) ). Deference is given to the debtor's decision, provided it demonstrates "that rejection of the contract will be likely to benefit the estate." Id. See also Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc ., 756 F.2d 1043, 1046 (4th Cir. 1985) (articulating a deferential "benefit to the estate" standard); In re: Genco Shipping & Trading Limited, 509 B.R. 455, 463 (Bankr. S.D.N.Y. 2014) ("A court should defer to a debtor's decision that rejection of a contract would be advantageous."); In re Malden Mills Industries, Inc., 303 B.R. 688, 701 (1st Cir. BAP 2004) ("A court will generally not second-guess a debtor's business judgment regarding whether the assumption or rejection of a contract will benefit the debtor's estate.").

An alternative articulation of the test is that the Court will approve a proposed assumption or rejection unless it is manifestly unreasonable or derives from bad faith, whim, or caprice. Western Wood, 2013 WL 1386285, at *21 (Court will not interfere unless the decision is "so manifestly unreasonable that it could not be based on sound business judgment") (quoting Lubrizol Enterprises, Inc., 756 F.2d at 1047 ); In re Sabine Oil & Gas Corp., 550 B.R. 59, 75 (Bankr. S.D.N.Y. 2016) (court will defer to debtor's decision to reject unless it is "the product of bad faith, whim, or caprice"); In re Cook, 2012 WL 5408905, *11 (Bankr. D.N.M. 2012) (same).

B. Specific Performance.

The HOA argues that rejection of the Settlement Agreement would be futile because the HOA would be entitled to specific performance in the event of a breach. The Court disagrees.

Rejection of an executory contract constitutes a breach of the contract as of the date immediately before the petition date. § 365(g)(1) ; In re Siggins, 2014 WL 1796685, at *5 (Bankr. D.N.M. 2014). The breach gives rise to a claim. § 502(g)(1). The non-debtor party's right to specific performance after rejection depends on whether the specific performance obligation qualifies as a "claim" that can be monetized and discharged.

A claim is defined to include a "right to an equitable remedy for breach of performance if such breach gives rise to a right to payment...." § 101(5)(B). As the Supreme Court noted:

Section [101(5)(B) ] ... is intended to cause the liquidation or estimation of contingent rights of payment for which there may be an alternative equitable remedy with the result that the equitable remedy will be susceptible to being discharged in bankruptcy. For example, in some States, a judgment for specific performance may be satisfied by an alternative right to payment in the event performance is refused; in that event, the creditor entitled to specific performance would have a ‘claim’ for purposes of a proceeding under title 11.

Ohio v. Kovacs, 469 U.S. 274, 280, 105 S.Ct. 705, 83 L.Ed.2d 649 (1985) (...