In re United Air Lines, Inc.

• Decision Date: 04 May 2006
• Docket Number: No. 05-1462.,No. 05-1461.,No. 05-1460.,05-1460.,05-1461.,05-1462.
• Citation: 447 F.3d 504
• Parties: In re: UNITED AIR LINES, INC., Debtor. United Air Lines, Inc., Appellant, v. U.S. Bank National Association, Inc., City of Los Angeles, et al., Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 504

447 F.3d 504

In re: UNITED AIR LINES, INC., Debtor.

United Air Lines, Inc., Appellant, v. U.S. Bank National Association, Inc., City of Los Angeles, et al., Appellees.

No. 05-1460.

No. 05-1461.

No. 05-1462.

United States Court of Appeals, Seventh Circuit.

Argued February 16, 2006.

Decided May 4, 2006.

Patrick McLaughlin (argued), Dorsey Whitney, Minneapolis MN, David A. Golin, Gesas, Pilati, Gesas & Golin, Chicago, IL, Charles P. Schulman, Sachnoff & Weaver, Chicago, IL, for Appellee.

James H.M. Sprayregen, Marc Kieselstein (argued), Kirkland & Ellis, Washington, DC, for Debtor-Appellant.

Before BAUER, EASTERBROOK, and MANION, Circuit Judges.

MANION, Circuit Judge.

To fund improvements at its facilities in the Los Angeles International Airport, United Air Lines, Inc., entered into a transaction with a bond-issuing, public entity named the Regional Airports Improvement Corporation ("RAIC"). Through this transaction, RAIC "subleases" certain airport facilities to United. After United entered bankruptcy, the true nature of the transaction was called into question. In adversary proceedings before the bankruptcy court against RAIC and two related parties (the City of Los Angeles and an indenture trustee), United sought to have the transaction treated as a loan rather than a lease for purposes of § 365 of the Bankruptcy Code, 11 U.S.C. § 365. The bankruptcy court ruled in United's favor, but the district court reversed. United appeals. We addressed a substantially similar matter concerning the San Francisco International Airport in United Air-lines, Inc. v. HSBC Bank USA, N.A., 416 F.3d 609 (7th Cir.2005), cert. denied, ___ U.S. ___, 126 S.Ct. 1465, ___ L.Ed.2d ___ (2006). As in the San Francisco appeal, we agree with United that the Los Angeles transaction is not a lease for § 365 purposes. We therefore reverse the district court's decision to the contrary.

Before detailing the Los Angeles transaction, it is helpful to reiterate the importance of the lease-versus-loan distinction in this context. When a lease is at issue, "[a] lessee must either assume the lease and fully perform all of its obligations, or surrender the property. 11 U.S.C. § 365. A borrower that has given security, by contrast, may retain the property without paying the full agreed price. The borrower must pay enough to give the lender the economic value of the security interest; if this is less than the balance due on the loan, the difference is an unsecured debt. See 11 U.S.C. § 506(a) and § 1129(b)(2)(A)." United Airlines, 416 F.3d at 610.¹

Since at least 1982, United has leased its space in the Los Angeles airport from the City of Los Angeles. In order to arrange financing to improve and construct facilities in that space, United worked with RAIC, which, as a public entity, could issue tax-exempt bonds. RAIC was formed by the City, but it is a separate legal entity. United's lease with the City anticipated that United would use RAIC's bond-issuing authority to fund the development of the airport facilities. On November 15, 1982, United and RAIC executed a transaction to achieve that end.

Two agreements are at the heart of the United-RAIC transaction. The first agreement is termed the "partial assignment," through which United assigned a portion of its leasehold (i.e., its interest under its lease with the City) to RAIC. In return, RAIC issued tax-exempt bonds, raising $75,750,000 to develop the facilities in question. Administrative matters related to these bonds, such as distributing payments to bondholders, are handled by an indenture trustee, currently U.S. Bank N.A.

The second agreement is entitled the "facilities sublease." Under this agreement, RAIC "leased" back the then to-be-developed facilities to United. In exchange, United pays "rent" that is equal to the amount necessary to cover the payments to the underlying bondholders plus administrative costs. Currently, the bondholders receive periodic interest-only payments and are also entitled to balloon payments for the outstanding principal, now $59,390,000, when the bonds mature. United has already redeemed bonds totaling $16,360,000 of the original $75,750,000. Presently, there are two sets of bonds outstanding. One set, with a balloon payment of $34,390,000 is due to mature on November 15, 2012, and the other, with a balloon payment of $25,000,000, is due to mature on November 15, 2021. These periodic and balloon "rental" payments from United go through the indenture trustee to the bondholders. The term of the sublease is completely dependent upon United's payment or redemption of the bonds. As such, the sublease is scheduled to expire in 2021 with the payment of the final set of outstanding bonds unless United redeems all the bonds earlier.

In the earlier appeal regarding United's dealings at the San Francisco airport, we resolved two key issues for deciding whether a transaction, such as the one before us, is a lease under § 365 of the Bankruptcy Code. The first issue was whether the form of the document should be controlling in this situation — that is, whether a transaction should be treated as a lease simply because the parties titled it a "lease" and used terms such as "rent." Agreeing with a number of other circuits' opinions, we concluded that § 365 mandates that the substance of the transaction trumps the form of the transaction. See United Airlines, 416 F.3d at 612 (citing In re PCH Assocs., 804 F.2d 193, 198-200 (2d Cir.1986); In re Pillowtex, Inc., 349 F.3d 711, 716 (3d Cir.2003); In re Moreggia & Sons, Inc., 852 F.2d 1179, 1182-84 (9th Cir.1988); In re Pac. Express, Inc., 780 F.2d 1482, 1486-87 (9th Cir.1986)). We reasoned: "It is unlikely that the Code makes big economic effects turn on the parties' choice of language rather than the substance of their transaction; why bother to distinguish transactions if these distinctions can be obliterated at the drafters' will?" United Airlines, 416 F.3d at 612. Accordingly, we held that, as a matter of federal law, the genuine nature of a transaction will prevail over the titles and terms used. See id. at 612-14.

The second issue we tackled in the prior case was whether federal or state law governed the lease-versus-loan determination — in other words, to which law should courts look to ascertain the "aspects of substance" that are important in deciding whether a transaction is a lease. Id. at 614. Because the Bankruptcy Code is silent on which economic features should shape the inquiry, we determined that, in general, the state law is controlling. See id. at 615 ("All of the states have devoted substantial efforts to differentiating leases from secured credit in commercial and banking law. Leases are state-law instruments, after all, and the norm in bankruptcy law is that contracts (of which leases are a species) and property rights in general have the same force they would have in state court, unless the Code overrides the state entitlement."). There is, however, an exception to this general rule. State law will not control if it conflicts with federal law by requiring a formalistic rather than a functional approach as described above. See id. This exception is not a concern in the present appeal. The applicable state law here is that of California, and, as we already determined in the San Francisco appeal, California law does not conflict with federal law in this regard. See id. at 615-16 (explaining Burr v. Capital Reserve Corp., 71 Cal.2d 983, 80 Cal. Rptr. 345, 458 P.2d 185 (1969) and Beeler v. Am. Trust Co., 24 Cal.2d 1, 147 P.2d 583 (1944)); see also Milana v. Credit Discount Co., 27 Cal.2d 335, 163 P.2d 869, 871 (1945) ("[I]f [achieving a loan is] the intent of the parties the transaction will be deemed a loan regardless of its form.").

The similarities between the substance of the present transaction (described above) and the substance of the transaction in our earlier opinion concerning the San Francisco airport are important. In the prior case, United had a long-running, traditional airport lease with the City and County of San Francisco. See United Airlines, 416 F.3d at 611. Then, to improve its facilities at the San Francisco airport, United worked with a bond-issuing, public entity named the California Statewide Communities Development Authority ("CSCDA"). See id. Through a series of agreements, CSCDA gave United $155 million in bond revenues to develop airport facilities. See id. at 611-12. The deal called for United to "sublease" a portion of its underlying leasehold with the City and County of San Francisco to CSCDA. See id. at 611. Then, CSCDA "leased" this same portion back to United in exchange for United's promise to make periodic "rental" payments that equated to the amounts needed to pay interest on the aforementioned bonds plus some administrative fees. See id. Additionally, United had to make a $155 million balloon payment at the end of the "lease" in order to retire the bonds. See id. An indenture trustee, HSBC Bank USA, N.A., administered bond-related matters for CSCDA, which included receiving United's "rental" payments and distributing those payments to the bondholders. See id. at 612.

There, like here, after United entered bankruptcy, the parties disputed whether the United-CSCDA transaction concerning the San Francisco airport was a lease under § 365. In our review of the substance of that transaction under California law, we concluded that it was a secured loan and not a lease based upon five aspects of the transaction: (1) the fact that United's "rental" payments were tied to the amount borrowed from the bondholders; (2) the presence of a balloon payment; (3) the presence of a "hell or high water" clause, meaning United had to pay the full "rental" amount if even the property became unusable; (4) the fact that prepayment of United's obligations would end the United-CSCDA arrangement; and (5) the fact that CSCDA did not have a remaining interest in the property at the...