Minges, Matter of

• Decision Date: 28 June 1979
• Docket Number: No. 777,D,777
• Citation: 602 F.2d 38
• Parties: , Bankr. L. Rep. P 67,205 In the Matter of James MINGES, Debtor. CONTROL DATA CORPORATION, Appellant, v. Steven ZELMAN, Trustee-Appellee. ocket 78-5051.
• Court: U.S. Court of Appeals — Second Circuit

Page 38

602 F.2d 38

5 Bankr.Ct.Dec. 452, Bankr. L. Rep. P 67,205

In the Matter of James MINGES, Debtor CONTROL DATA CORPORATION, Appellant, v. Steven ZELMAN, Trustee-Appellee.

No. 777, Docket 78-5051.

United States Court of Appeals Second Circuit.

Argued April 23, 1979.

Decided June 28, 1979.

John B. Nolan, Hartford, Conn. (Day, Berry & Howard, Allan B. Taylor, Hartford, Conn., of counsel), for appellant Control Data Corp.

Dwight Owen Schweitzer, Hartford, Conn., for trustee-appellee Steven Zelman.

Elliott B. Pollack, Hartford, Conn. (Hoberman, Pollack & Roseman, Howard L. Siegel, Hartford, Conn., of counsel), for Capital for Technology Corp.

Before WATERMAN, FEINBERG and MANSFIELD, Circuit Judges.

FEINBERG, Circuit Judge:

Control Data Corporation, lessee of space in an office building owned by James Minges, the debtor in a Chapter XII proceeding, appeals from an order of the United States District Court for the District of Connecticut, M. Joseph Blumenfeld, J., permitting appellee Steven Zelman, the debtor's Chapter XII trustee, to reject certain covenants in the lease. The order of the district court affirmed an order of bankruptcy judge Saul Seidman. For reasons set forth below, we remand the case for further findings.

I

So far as we can tell from the somewhat sketchy record before us, the following facts appear to be undisputed. Control Data Corporation, which we shall refer to as the lessee, is the successor in interest of Service Bureau Corporation, the original signatory to the lease with Minges for second floor office space in an office complex called Pro Park in Farmington, Connecticut. The lease provided for a 10-year term, commencing December 1, 1967, with an option in the tenant to extend in successive two-year terms for up to 10 more years. Under the lease, the landlord is obligated to furnish hot and cold water, heat, air-conditioning (including the necessary electricity) and janitorial services. The tenant pays utility charges only for lighting its office premises and for the office machines. These charges are separately metered and billed directly to the tenant by the utility company. The lease also gives the tenant a right of first refusal of all other space in the same building and the right to require the landlord to provide up to 16,000 square feet of additional space. The lessee uses the premises 24 hours a day, every day of the year, as a computer facility and service bureau operation. The lease also provides that it is subordinate to any mortgage but that the mortgage shall contain provisions that the mortgagee, in the event of foreclosure "will not attempt to terminate this lease . . . nor interfere with the rights of" the lessee, if the latter is not in default.

In October 1972, Capital for Technology Corporation (CTC) made a loan to Minges, which was secured by a second mortgage on Pro Park. CTC's parent, Hartford National Bank, also obtained a third mortgage on the property. A year later, CTC paid the arrearages on the first mortgage and exercised its right to take possession of Pro Park. CTC then began a foreclosure action in the state courts and obtained a judgment. Execution of that judgment, however, was stayed after Minges filed his Chapter XII petition in October 1974. The bankruptcy court has allowed CTC to remain as mortgagee in possession of Pro Park, managing the property and collecting the rents.

In September 1976, the Chapter XII trustee petitioned the bankruptcy court to allow him to reject certain portions of the lease as burdensome pursuant to section 413(1) of the Bankruptcy Act. These are the provisions that require the landlord to provide utilities and janitorial service, that grant the tenant the right of first refusal on space in the building that becomes vacant, and that allow the tenant to extend the lease on the original space for five additional two-year terms. According to the bankruptcy judge, there was evidence at the hearing that the value of the space rented under the lease has increased considerably since 1967 from $4.30 per square foot, the lease rate, to "$7.00 per foot or more." The bankruptcy judge also found that in 1967 a reasonably prudent landlord would have expected to spend each year about $7,000 on electricity and $3,000-$4,000 on janitorial service. In contrast, the landlord's annual cost of supplying these services to the lessee in 1975 was approximately.$19,000 and $15,250 a year respectively.

After the hearing, the bankruptcy judge in a lengthy opinion granted the trustee's petition to reject the landlord's covenants to supply utilities and janitorial service as well as the tenant's right to additional space, but denied the petition with regard to the tenant's options to extend the term of the lease. Judge Blumenfeld, in a brief opinion, affirmed the decision of the bankruptcy judge. The trustee has not appealed from the portion of the ruling that was adverse to him, and the lessee apparently does not contest in this court the trustee's rejection of the lessee's right to first refusal on additional space. This appeal, therefore, concerns the trustee's rejection of the landlord's covenants to supply utilities and janitorial service.

II

Appellant lessee argues to us that the bankruptcy judge applied the wrong legal standards in deciding whether to grant the relief sought by the trustee. Thus, appellant argues that to justify rejection of the lease, or any part of it, the trustee had to show that the lease caused a net loss to the estate rather than merely insufficient profits, that rejection will serve the purpose of Chapter XII, and that rejection will benefit creditors other than CTC and its parent, which are secured by mortgages. None of these conditions, appellant says, was met.

Before assessing these arguments, the statutory scheme must be briefly reviewed. In proceedings initiated under various chapters of the Bankruptcy Act, the bankruptcy court may allow the trustee or debtor in possession to reject executory contracts of the debtor. Thus, the trustee or debtor, in the proper circumstances, may cancel pre-bankruptcy executory contracts of the debtor that are burdensome. See Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn.L.Rev. 439, 447-50 (1973). When such rejection occurs, the other party to the rejected contract becomes a general creditor of the estate for any damages flowing from the rejection. See section 63a(9), c. See also 3A Collier on Bankruptcy PP 63.31, 63.35 (1975). ¹

Turning specifically to Chapter XII provisions, section 413(1) of the Act provides:

Upon the filing of a petition, the court may, in addition to the jurisdiction, powers, and duties hereinabove and elsewhere in this chapter conferred and imposed upon it

(1) permit the rejection of executory contracts of the debtor, upon notice to the parties to such contracts and to such other parties in interest as the court may designate;

Section 406(4) of the Act defines "executory contracts" as including "unexpired leases of real property." Section 442 gives a Chapter XII trustee the powers of a bankruptcy trustee under section 44, and such a trustee, under section 70b must either assume or reject executory contracts "including an unexpired lease of real property." Therefore, there is no doubt that a Chapter XII trustee has the power, with the permission of the court, to reject a lease as an executory contract. See In re Freeman, 49 F.Supp. 163 (S.D.Ga.1943), questioned on other grounds, Matter of Garfinkle, 577 F.2d 901, 904 n. 4 (5th Cir. 1978). See also 9 Collier on Bankruptcy P 3.03 (1978). Indeed, appellant does not take a contrary position.

Although leases are generally treated as executory contracts in the bankruptcy context, they raise some unique considerations, particularly in the relatively rare instance where it is a debtor landlord who seeks to reject the lease. ² A lease is partly the conveyance of an estate, which is deemed fully executed once the tenant takes possession. Therefore, the weight of authority is that the conveyance aspect of a lease may not ordinarily be unilaterally disturbed by a debtor landlord or his trustee. See 9 Collier on Bankruptcy P 3.03 at 799-800 (1978). See also Matter of Garfinkle, supra, 577 F.2d at 904 n. 4 (5th Circuit sharply criticizing In re Freeman, supra, 49 F.Supp. at 165, holding that a lessor's disaffirmance of a lease in a Chapter XII proceeding renders the lessee merely a tenant at sufferance); In re New York Investors Mutual Group, 153 F.Supp. 772, 775 (S.D.N.Y.1957) (Weinfeld, J.), aff'd sub nom., Cohen v. East Netherland Holding Co., 258 F.2d 14, 16 (2d Cir. 1958); Revised Bankruptcy Act, 11 U.S.C.A. § 365(a), (h) (Supp.1979) (effective October 1, 1979). This view, that a lessee's possession may not be disturbed by the Chapter XII rejection power, may also be compelled by section 402 of the Act, which provides that the provisions of Chapters I to VII apply to Chapter XII where "not inconsistent" with it. Section 70b, part of Chapter VII, provides that

Unless a lease of real property expressly otherwise provides, a rejection of the lease or of any covenant therein by the trustee of the lessor does not deprive the lessee of his estate.

The 5th Circuit apparently takes the position that this language is "not inconsistent" with Chapter XII. See Garfinkle, supra, 577 F.2d at 904 n. 4. In this case, the Chapter XII trustee is not seeking to disturb the lessee's possession.

Another nice question that arises with respect to unexpired leases is whether under the Bankruptcy Act they may be rejected in part, i.e., on a clause by clause basis, or only as a whole. Collier states generally that executory contracts must be either rejected or assumed as a whole. See, e.g., 4A Collier on Bankruptcy P 70.42(1) at 500 (1978). But leases may be an exception, as the bankruptcy judge held in this case, since section 70b speaks of "rejection of the lease Or of any covenant therein . . . ." (...