LCO Enterprises, In re

• Decision Date: 30 December 1993
• Docket Number: No. 92-15825,92-15825
• Citation: 12 F.3d 938
• Parties: , 25 Bankr.Ct.Dec. 136, Bankr. L. Rep. P 75,648 In re LCO ENTERPRISES, Debtor. Lincoln ALVARADO; Patrician Associates, Inc.; LPC Alvarado Phase II, Appellees, v. Edward M. WALSH, Trustee, Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 938

12 F.3d 938

62 USLW 2449, 25 Bankr.Ct.Dec. 136, Bankr.

L. Rep. P 75,648

In re LCO ENTERPRISES, Debtor Lincoln ALVARADO; Patrician Associates, Inc.; LPC Alvarado Phase II, Appellees, v. Edward M. WALSH, Trustee, Appellant.

No. 92-15825.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Oct. 7, 1993.

Decided Dec. 30, 1993.

Melanie M. Darling, Goldberg, Stinnett & MacDonald, San Francisco, CA, for appellant.

Barry Milgrom, Michael St. James, Rosenblum, Parish & Bacigalupi, San Francisco, CA, for appellees.

Appeal from the Ninth Circuit Bankruptcy Appellate Panel, Russell, Perris and Ashland, Bankruptcy Judges, Presiding.

Before: TANG, TROTT and FERNANDEZ, Circuit Judges.

FERNANDEZ, Circuit Judge:

This appeal concerns the mechanics of applying the "greater amount" test of 11 U.S.C. Sec. 547(b)(5) to determine whether a prepetition payment to a landlord constitutes a preference. The question before us is whether the bankruptcy court must hypothesize whether a hypothetical chapter 7 trustee would assume a lease, or whether the court must base its analysis on the fact that the lease was actually assumed in the chapter 11 proceedings. We conclude that the hypothetical chapter 7 analysis required by Sec. 547(b)(5) ¹ must be based on the actual facts of the case and affirm the decision of the Bankruptcy Appellate Panel.

BACKGROUND FACTS

LCO Enterprises was formed in 1981 to provide merchandise warehousing and distribution services. LCO's business flourished. Over the next seven years it expanded from a 25,000 square foot warehouse to a 500,000 square foot custom-designed facility. When LCO lost its largest customer, it was forced to scale back operations. LCO vacated its warehouse and leased space from Lincoln Alvarado and Patrician Associates, Inc. (collectively "Lincoln") in late 1988 and early 1989. LCO executed a five-year lease with a monthly rent of approximately $25,000, and two month-to-month leases with monthly rents of approximately $22,000 and $15,000. Within only a few months, LCO fell behind in paying the rent. It made partial rent payments in April, May and June, which totaled $92,007.46, but about $175,496 was still owed for those three months.

Recognizing that the situation was worsening for both parties, LCO and Lincoln restructured their relationship. The parties agreed to a reduction in the amount of leased space, a reduction in rent, and the execution of a new long-term lease. With respect to the $175,496 arrearage, Lincoln agreed to accept payment of $75,000 over four years and to forgive the balance. The restructured lease arrangement was recorded in a chapter 11 disclosure statement and plan and distributed to LCO's creditors. The plan was to be funded by a $200,000 cash contribution from LCO's shareholders and a new investor. Thereafter, on June 13, 1989, LCO filed a voluntary petition for reorganization under chapter 11 of the Bankruptcy Code. The plan was confirmed on July 21, 1989.

On September 13, 1989, Edward M. Walsh was appointed as chapter 11 trustee ("Trustee") with limited powers to act as disbursing agent, to object to claims, and to investigate and pursue any preferential payments or fraudulent transfers. The Trustee filed this adversary proceeding against Lincoln on November 30, 1989. He sought to set aside, pursuant to Sec. 547(b), the $92,007.46 partial rent payments made prior to the filing of the petition.

Lincoln moved for summary judgment and argued that the Trustee could not prove that Lincoln improved its position, within the meaning of Sec. 547(b)(5), as a matter of law. The bankruptcy court denied Lincoln's motion. It held that there was a material issue of fact as to whether a hypothetical chapter 7 trustee would have assumed the lease. In re LCO Enters., 116 B.R. 188 (Bankr.N.D.Cal.1990). ² The Bankruptcy Appellate Panel granted leave for an interlocutory appeal and reversed. In re LCO Enters., 137 B.R. 955 (9th Cir. BAP 1992).

JURISDICTION AND STANDARD OF REVIEW

The BAP had jurisdiction pursuant to 28 U.S.C. Sec. 158(b). Our jurisdiction is

premised on 28 U.S.C. Sec. 158(d). We are in as good a position as the BAP to review the decision of the bankruptcy court. Thus, we review de novo the bankruptcy court's denial of summary judgment. Viewing the evidence in the light most favorable to the Trustee, we must determine whether there are any genuine issues of material fact and whether the bankruptcy court correctly applied the relevant substantive law. See In re United Energy Corp., 944 F.2d 589, 593 (9th Cir.1991).

DISCUSSION

Section 547(b) of the Bankruptcy Code enables the Trustee to recover for the benefit of the estate certain payments made by a debtor to a creditor within the 90 days preceding the filing of the bankruptcy. A payment is avoidable as a preference only if the payment improved the creditor's position as compared to other creditors of the same class. 11 U.S.C. Sec. 547(b)(5). Section 547(b)(5) provides that the trustee may avoid any transfer of an interest of the debtor in property:

(5) that enables such creditor to receive more than such creditor would receive if--

(A) the case were a case under chapter 7 of this title;

(B) the transfer had not been made; and

(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

This section, sometimes referred to as the "greater amount" test, requires the court to construct a hypothetical chapter 7 case and determine what the creditor would have received if the case had proceeded under chapter 7. See In re Ehring, 900 F.2d 184, 188 (9th Cir.1990); In re Lewis W. Shurtleff, Inc., 778 F.2d 1416, 1420-22 (9th Cir.1986); 4 Collier on Bankruptcy p 547.08 (Lawrence P. King, ed., 15th ed. 1993).

The starting point in the "greater amount" analysis is identification of the class to which the creditor belongs. See In re Lewis W. Shurtleff, 778 F.2d at 1421. That classification is the crux of this appeal. In an ordinary case, the amount and priority of an unsecured creditor's claim is fixed on the date of the filing of the petition. Similarly, on the date of the filing, a secured creditor's claim is fixed in amount, the value of the security as of that date can be ascertained and the claim will be either fully or partially secured. The debtor's lessor, however, stands in a different position. Although the amount of the debtor's prepetition default under the lease may be fixed on the date of the filing, the status of the lessor's right to payment from the estate is not yet fixed. That is because the lessor's position relative to other creditors depends on whether the lease is assumed or rejected. If the lease is assumed, the lessor is entitled to prompt payment in full of any default under the lease, and the debtor is entitled to continued use of the property. 11 U.S.C. Sec. 365(b). If the lease is rejected, the lessor is entitled to immediate possession of his property and holds an unsecured claim for the unpaid rent. See In re Elm Inn, Inc., 942 F.2d 630, 633-34 (9th Cir.1991).

More importantly, in this case the difference between assumption and rejection determines the outcome of the preference action. If the lease is assumed, the debtor must cure any default. 11 U.S.C. Sec. 365(b). Thus, if rent payments had not been made prepetition, they had to be made at the time of assumption. LCO had to pay Lincoln the full amount of rent (or any lesser amount to which Lincoln agreed) either prepetition or at the time of assumption. For purposes of the "greater amount" test, Lincoln stands in a position similar to that of a secured creditor. If a creditor is fully secured, a prepetition transfer to him is not preferential because the secured creditor is entitled to 100% of his claim. See In re World Fin. Serv. Ctr., Inc., 78 B.R. 239, 241-42 (9th Cir. BAP 1987), aff'd, 860 F.2d 1089 (9th Cir.1988); In re Ludford Fruit Prods., Inc., 99 B.R. 18, 22 (Bankr.C.D.Cal.1989). On the other hand, if the lease is rejected, Lincoln would have possession of the property and hold an unsecured claim for unpaid rent. As long as the distribution to unsecured creditors is less than 100%, any rent paid to Lincoln within the preference period and outside the ordinary course of business would be preferential. See In re Lewis W. Shurtleff, 778 F.2d at 1421. The liquidation analysis in the disclosure In this case, the lease was actually assumed. LCO's intent to assume was announced to the creditors when the disclosure statement and plan were distributed and approved by the bankruptcy court when the plan was confirmed. LCO's default was cured as required by Sec. 365(b) and LCO retained possession of the property. The Trustee takes the position that a hypothetical chapter 7 trustee might have rejected the lease. He suggests that the bankruptcy court should exercise its own independent judgment as to whether, if the court were administering the estate under chapter 7, it would have assumed or rejected the lease. Thus, the Trustee seeks to obtain the benefits of both assumption and rejection, i.e., continued possession of the property and recovery of the prepetition rent. That would not be possible in chapter 7. It is not possible in chapter 11.

statement estimated a 2.4% distribution to unsecured creditors. Accordingly, if the lease is considered to have been rejected, Lincoln must return the $92,007.46 LCO paid in April, May and June.

The Trustee justifies his position by claiming that the court can only consider the state of events on the date of the filing of the petition. Section 547 is silent regarding the point in time for analyzing whether a payment is preferential. The first four elements of Sec. 547(b) focus on the time the payment is made. 4 Collier, supra, p 547.08, at 547-42 n. 4. But Sec. 547(b)(5) has been construed to mean that the court must determine the relative positions of the creditors on the date the petition is filed. See Palmer Clay...