United States Court of Appeals
Fifth Circuit
F I L E D
IN THE UNITED STATES COURT OF APPEALS
November 8, 2005
FOR THE FIFTH CIRCUIT
_____________________ Charles R. Fulbruge III
Clerk
No. 04-10494
_____________________
In Re: STONEBRIDGE TECHNOLOGIES, INC.,
Debtor.
-----------------------
EOP-COLONNADE OF DALLAS LIMITED PARTNERSHIP,
Appellant,
versus
DENNIS FAULKNER, In his capacity as Trustee of the SBTI Liquidating
Trust,
Appellee.
__________________________________________________________________
Appeal from the United States District Court
for the Northern District of Texas, Dallas Division
USDC Nos. 3:03-CV-1979-P and 3:03-CV-1980-P
_________________________________________________________________
Before KING, Chief Judge, and JOLLY and DENNIS, Circuit Judges.
PER CURIAM:
The trustee (the “Trustee”) of the liquidating trust
established under the confirmed Chapter 11 plan of Stonebridge
Technologies, Inc. (“Stonebridge”) brought an adversary action, as
lessee (the “Lessee”), against EOP-Colonnade of Dallas Limited
Partnership (“EOP” or the “Lessor”), the lessor, in connection with
EOP’s draw on a letter of credit that was provided as security for
Stonebridge’s commercial lease obligations with EOP. The Trustee
asserted, in the bankruptcy court, that EOP breached the lease and
made negligent misrepresentations to the issuing bank by
prematurely drawing on the letter of credit and retaining an amount
in excess of the claim cap of 11 U.S.C. § 502(b)(6). The
bankruptcy court found that EOP did breach the lease and made
negligent misrepresentations by prematurely drawing on the letter
of credit and retaining an amount in excess of the § 502(b)(6) cap.
The district court affirmed the bankruptcy court’s order, and EOP
now appeals. We REVERSE. Because EOP did not file a claim in the
bankruptcy case, we hold that the § 502(b)(6) cap was not
triggered. Further, we hold that EOP did not prematurely draw on
the letter of credit. EOP, therefore, did not breach the lease or
make negligent misrepresentations to the issuing bank.
I
On September 21, 2000, EOP and Stonebridge entered into a
lease (“Lease”), in which Stonebridge agreed to lease space in an
EOP-owned office building. Under the terms of the Lease,
Stonebridge was required to provide a security deposit to EOP,
defined as “$105,298.85 in cash and a letter of credit in the
amount of $1,430,065.74.”
Stonebridge provided EOP with a cash payment of $105,298.85
and an irrevocable stand-by letter of credit for $1,430,065.74
(“Letter of Credit”) issued by the Bank of Oklahoma (“Bank”) in
favor of EOP. Stonebridge executed a note payable to the Bank,
secured by a certificate of deposit for $1,250,000, to reimburse
the Bank in the event of a draw on the Letter of Credit.
2
On September 6, 2001, Stonebridge filed a Voluntary Petition
under Chapter 11 of the United States Bankruptcy Code. At the time
of the filing, Stonebridge owed EOP $71,895.61 for miscellaneous
charges and expenses plus rent for September 2001. After filing
the bankruptcy petition, Stonebridge paid EOP $50,000 to be applied
against September 2001 post-petition rent. Stonebridge also
initiated negotiations with EOP to reduce its lease obligations,
seeking an agreement to reject the Lease as soon as possible and
enter into a new short-term lease.
On October 23, EOP and Stonebridge announced an agreement in
open court that the Lease would be rejected effective no earlier
than October 1, 2001 and no later than October 23, 2001. It became
clear at this time that the parties intended the effective
rejection date to occur within that window of time, regardless of
when the bankruptcy court issued its final order approving the
rejection.
Prior to the October 23 court appearance, EOP initiated a draw
request on October 22 to the Bank under the Letter of Credit for
the full amount of the Letter of Credit. The Bank received the
draw request on October 23, but refused to honor it because the
request was technically deficient. Three days later, after
correcting the deficiencies, EOP delivered another draw request to
the Bank. The Bank received and promptly processed the second draw
request, which became effective as of October 25. The Bank honored
3
the Letter of Credit on October 30 by issuing a check for
$1,430,965.74 and delivering it to EOP.
On November 8, the bankruptcy court entered a nunc pro tunc
order approving the rejection of the Lease, rendering the rejection
effective as of October 1, 2001. As part of the agreement to
reject the Lease, EOP was allowed an administrative post-petition
rent claim in the amount of $42,137.50, and the parties agreed that
pre-petition rent due from September 1 to September 5 was
$17,549.81. The record conclusively demonstrates, however, that
EOP never filed a proof of claim for its actual lease rejection
damages following the bankruptcy court order rejecting the lease
and approving EOP’s administrative rent claim.
On December 12, the Bank sought relief from the automatic stay
to apply Stonebridge’s certificate of deposit as reimbursement for
EOP’s draw on the Letter of Credit. The Trustee reached a
compromise with the Bank, allowing the certificate of deposit to be
applied in exchange for an assignment of the Bank’s claims against
EOP for the allegedly improper draw upon the Letter of Credit. The
Trustee then brought this adversary action in the bankruptcy court
alleging that EOP breached the Lease and, as assignee, alleging
that EOP made negligent misrepresentations to the Bank, by
prematurely drawing on the letter of credit and retaining an amount
in excess of the § 502(b)(6) cap.
The bankruptcy court held that EOP prematurely drew on the
Letter of Credit and retained an amount in excess of the §
4
502(b)(6) cap, resulting in a breach of the Lease and negligent
misrepresentations to the Bank that the funds were “due and owing.”
In re Stonebridge Technologies, 291 B.R. 63 (Bankr. N.D. Tex. Apr.
4, 2003). In ruling in favor of the Trustee, the bankruptcy court
reasoned that because the Letter of Credit was part of the security
deposit, it was subject to the § 502(b)(6) cap. The bankruptcy
court also found that EOP’s draw of the full amount of the Letter
of Credit before the entry of the nunc pro tunc Lease rejection
order was a breach of the Lease and constituted a negligent
misrepresentation to the Bank that the full sum of the Letter of
Credit was “due and owing.” The bankruptcy court awarded to the
estate: (i) damages in the amount of $180,065.74 for EOP’s
negligent misrepresentation to the Bank, calculated by the
difference between the amount EOP drew on the Letter of Credit and
the amount the Bank received from the certificate of deposit
securing its obligations against the Stonebridge estate; and (ii)
damages in the amount of $2,267.23 for EOP’s breach of the Lease,
calculated by the difference between what EOP would have been
entitled to claim under 11 U.S.C. § 502(b)(6) (less a cash security
deposit) and the amount the Bank collected on the certificate of
deposit. EOP appealed to the district court, and the district
court affirmed the bankruptcy court’s ruling on January 30, 2004.
EOP now appeals.
II
A
5
We apply the same standard of review as the district court:
the bankruptcy court’s conclusions of law and mixed questions of
law and fact are reviewed de novo. AT&T Universal Card Servs. v.
Mercer (In re Mercer), 246 F.3d 391, 402 (5th Cir. 2001) (en banc).
Findings of fact are reviewed for clear error. Id.
B
We must begin our consideration of this case by examining the
jurisdiction of the bankruptcy court (and by extension the
jurisdiction of the district court and this court). Neither party
has raised jurisdictional issues,1 but we are obligated to raise
the matter sua sponte, certainly when jurisdiction appears
questionable. See In re Bass, 171 F.3d 1016, 1021 (5th Cir. 1999).
This appeal considers four claims brought by the Trustee
against EOP in an adversary proceeding arising from Stonebridge’s
bankruptcy. Two claims directly relate to damage allegedly done
directly to the estate by EOP’s actions: (1) breach of the Lease
by prematurely drawing on the Letter of Credit and (2) breach of
the Lease by retaining an amount in excess of the § 502(b)(6) cap.
The other two claims were assigned to the Trustee by the Bank: (3)
negligent misrepresentation to the Bank that sums were “due and
owing” by prematurely drawing on the Letter of Credit and (4)
1
Neither party has previously raised the question of general
bankruptcy jurisdiction. EOP, however, has raised the question of
core versus non-core bankruptcy jurisdiction before both the
bankruptcy and district courts.
6
negligent misrepresentation to the Bank that sums were “due and
owing” by drawing proceeds in excess of the § 502(b)(6) cap.
District courts have jurisdiction over bankruptcy cases, and
they may refer cases at their discretion to bankruptcy courts. 28
U.S.C. § 1334 (district court jurisdiction); 28 U.S.C. § 157
(bankruptcy court jurisdiction). The jurisdictional grant to the
bankruptcy court is divided into “core” and “non-core” proceedings.
Core proceedings arise under title 11 or arise in a case under
title 11. 28 U.S.C. § 157(b). Non-core proceedings are those
proceedings that are otherwise related to a case under title 11.
28 U.S.C. § 157(c)(1). Bankruptcy judges may enter all appropriate
orders and judgments in core proceedings, but unless the parties
consent to core treatment, a bankruptcy judge must submit proposed
findings of fact and conclusions of law in non-core proceedings to
the district court. 28 U.S.C. § 157(b)-(c).
To determine whether a particular matter falls within general
bankruptcy jurisdiction, we ask whether the outcome of that
proceeding could have any conceivable effect on the estate being
administered in bankruptcy. Wood v. Wood (In re Wood), 825 F.2d
90, 93 (5th Cir. 1987). More specifically, an action is related to
bankruptcy if “the outcome could alter the debtor’s rights,
liabilities, options, or freedom of action (either positively or
negatively) and which in any way impacts upon the handling and
administration of the bankrupt estate.” In re Majestic Energy
Corp., 835 F.2d 87, 90 (5th Cir. 1988) (quoting Pacor Inc. v.
7
Higgins, 743 F.2d 984, 994 (3d Cir. 1984)). This inquiry is
straightforward with respect to the breach of the Lease claims: The
Lease is property of the bankruptcy estate in this case and,
therefore, any breach of the Lease has an effect on the estate.
Any recovery on the claims brought by the bankrupt for breach of
the Lease goes directly to the estate for damage done to the
estate.
With respect to the claims for negligent misrepresentations
that EOP made to the Bank, jurisdiction is less obvious. Although
the claims are now owned by the estate by virtue of the assignment
to the Trustee, they arise from litigation rights of a third party,
the Bank. At first glance, one might conclude that because the
estate stands in the shoes of the Bank, and the bankruptcy court
had no jurisdiction to litigate the Bank’s claim against EOP, the
bankruptcy court could not assert jurisdiction over the claim just
because the Bank’s cause of action had been assigned to the
estate.2 Finding that assignment alone creates bankruptcy
jurisdiction to litigate a third party’s cause of action defeats
the limited scope of bankruptcy jurisdiction. Upon closer review,
however, additional effects on the estate are evident: a claim by
the Bank against EOP affects the need for the Bank to seek
2
At oral argument before this court, counsel for the Trustee
admitted that the assigned claims would not be within the
bankruptcy court’s jurisdiction if those claims had been brought by
the Bank. We do not judge the accuracy of this statement, but note
that it is such an intuition that led this Court to raise the
question of jurisdiction sua sponte.
8
reimbursement from Stonebridge’s bankruptcy estate. EOP’s draw on
the Letter of Credit triggered Stonebridge’s contractual
responsibility to reimburse the Bank for the draw on the Letter of
Credit. Here, however, the Bank also sought damages against EOP
for negligent misrepresentation. If the Bank is successful against
EOP on its negligent misrepresentation claims, the need for
reimbursement from Stonebridge’s estate is alleviated.3 This
effect on the estate is not altered because the Trustee exchanged
reimbursement to the Bank for an assignment of the Bank’s negligent
misrepresentation claims. The negligent misrepresentation claims
therefore fall within the general bankruptcy jurisdiction.
Having decided that all four claims are within the general
bankruptcy jurisdiction, we then must decide whether the claims are
core or non-core. A proceeding is core “if it invokes a
substantive right provided by title 11 or if it is a proceeding
that, by its nature, could arise only in the context of a
bankruptcy case.” Wood, 825 F.2d at 97. Again, this inquiry is
relatively easy with respect to the breach of the Lease claims.
Although the breach of the Lease claims are grounded in state
contract law, the controlling questions for this case involve the
3
Similarly, other cases that involve litigation between
third parties have been found to have an effect on the
administration of the bankruptcy estate, including suits by
creditors against guarantors and a suit by creditors of a debtor
against defendants that allegedly perpetrated a fraud. See 3
COLLIER ON BANKRUPTCY ¶ 3.01 (15th ed. rev. 2005) (citations omitted).
9
interpretation of substantive rights provided by title 11, the
§ 502(b)(6) cap and lease rejection under § 365(a).
On the other hand, claims between third parties, such as the
negligent misrepresentation claims, are typically considered within
the bankruptcy court’s non-core jurisdiction. In this case,
however, the negligent misrepresentation claims are dependent upon
the interpretation of rights created in bankruptcy, specifically
those rights associated with § 502(b)(6) and § 365(a). Although
the grafting of bankruptcy terms onto the interpretation of a Lease
does not automatically result in core jurisdiction, as a practical
matter, these particular negligent misrepresentation claims are
substantively related to the interpretation of rights created in
bankruptcy. In other words, the substantive rights asserted by the
Trustee could arise only in the context of a bankruptcy case.
Because these claims are dependent upon the rights created in
bankruptcy and would not exist but for the filing of Stonebridge’s
bankruptcy, we find that these claims should be included within the
bankruptcy court’s core jurisdiction. See generally Northern
Pipeline Const. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982)
(defining the limits of Article III jurisdiction of bankruptcy
courts, later codified into core and non-core jurisdiction by
Bankruptcy Amendments and Federal Judgeships Act of 1984, P.L. No.
98-353).
In sum, the bankruptcy court had core jurisdiction over all of
the claims currently on appeal from the adversary proceeding under
10
28 U.S.C. § 1334 and § 157(b). The district court had jurisdiction
to review the bankruptcy court’s order under 28 U.S.C. § 158(a).
We then have jurisdiction to review this appeal under § 158(d), so
we proceed to address the merits.
C
For ease of substantive analysis, we consider the causes of
action alleged by the Trustee against EOP together (breach of the
Lease and negligent misrepresentation4), but divide the claims into
4
To present a claim of negligent misrepresentation,
Stonebridge must prove: (1) EOP made a representation in the
course of business, or in a transaction in which EOP had a
pecuniary interest; (2) EOP supplied false information for the
guidance of the Bank in its business transactions; (3) EOP failed
to exercise reasonable care or competence in obtaining or
communicating this information; (4) the Bank justifiably relied on
the representation; and (5) EOP’s misrepresentation proximately
caused the Bank pecuniary injury. See McCamish, Martin, Brown &
Loeffler v. F.E. Appling Interests, 991 S.W.2d 787, 791 (Tex.
1991). The only disputed issue before us is whether EOP falsely
represented to the Bank that the full amount of the Letter of
Credit was “due and owing.” The inquiries undertaken to determine
whether EOP falsely represented to the Bank and whether EOP
breached the Lease are identical.
The parties do not raise the issue whether a tort action in
the form of a negligent misrepresentation claim is available to the
Bank, and thus to the Trustee as assignee of the Bank’s claims,
under these circumstances. See generally In re Zamora, 274 B.R.
268, 274 (Bankr. W.D. Tex. 2002) (“With the Code’s silence, the
presumption is that the normal rules regarding the enforceability
of valid assignments apply.”). Thus, this opinion does not decide
whether such a claim is indeed available to issuers of letters of
credit when a misrepresentation is made in connection with a draw
upon a letter of credit and nothing in this opinion should be read
to indicate that such a cause of action exists. Because of the
parties’ failure to address the issue, however, we analyze the
Trustee’s negligent misrepresentation claim under the elements of
the traditional tort action.
11
two groups: (1) the claims for draw/retention in excess of the
§ 502(b)(6) cap and (2) the claims for premature draw.
1
We first examine the claims against EOP for drawing against
the Letter of Credit an amount in excess of the § 502(b)(6) cap.5
Section 502 of the Bankruptcy Code, entitled “Allowance of
claims or interests”, provides that claims or interests are deemed
allowed unless a party in interest objects. 11 U.S.C. § 502(a).
If an objection is made, the court determines the amount of such a
claim and allows the claim in the determined amount, except to the
extent that certain specified conditions exist. 11 U.S.C. §
502(b). Section 502(b)(6) provides:
(b) Except as provided in subsections (e)(2), (f), (g), (h)
and (i) of this section, if such objection to a claim is made,
the court, after notice and a hearing, shall determine the
amount of such claim in lawful currency of the United States
as of the date of the filing of the petition, and shall allow
such claim in such amount, except to the extent that–-
(6) if such claim is the claim of a lessor for damages
resulting from the termination of a lease of real
property, such claim exceeds--
(A) the rent reserved by such lease,
without acceleration, for the
greater of one year, or 15 percent,
not to exceed three years, of the
remaining term of such lease,
following the earlier of --
5
Although mechanical differences may exist between drawing
and retaining funds from a letter of credit, the application of §
502(b)(6) does not turn on these distinctions in this case. See
Eakin v. Cont’l Ill. Nat’l Bank & Trust Co. of Chicago, 875 F.2d
114, 116 (7th Cir. 1989) (“Letters of credit are designed to avoid
complex disputes about how much the beneficiaries ‘really’ owe.
The promise and premise are ‘pay now, argue later.’”).
12
(i) the date of the filing of
the petition; and
(ii) the date on which such
lessor repossessed, or
the lessee surrendered,
the leased property; plus
(B) any unpaid rent due under such
lease, without acceleration, on the
earlier of such dates.
This limitation prevents a lessor who files a claim against the
estate from reaping an unfair share of the bankruptcy estate over
the remaining pool of unsecured creditors. S. Rep. No. 95-989,
reprinted in 1978 U.S.C.C.A.N. 5787, 5849; H.R. Rep. No. 95-595,
reprinted in 1978 U.S.C.C.A.N. 5963, 6309 (the purpose of the
statute is “to compensate the landlord for his loss while not
permitting a claim so large (based on a long-term lease) as to
prevent other general unsecured creditors from recovering a
dividend of the estate.”).
In this case, the Lessor’s need to file a claim against the
bankruptcy estate was obviated by the fact that the Lessee’s
obligations were substantially secured by cash and a letter of
credit, to which the Lessor turned when the Lessee defaulted.6 The
Lessor’s draw on the letter of credit is the focus of the Trustee’s
arguments. It is well-established in this circuit that letters of
credit and the proceeds therefrom are not property of the debtor’s
bankruptcy estate. Kellogg v. Blue Quail Energy, Inc. (In re
6
The filing of a proof of claim serves no purpose if the
creditor is secured or has not asserted a claim against the estate.
See 4 COLLIER ON BANKRUPTCY ¶ 501.01[3][a] (15th ed. rev. 2005).
13
Compton Corp.), 831 F.2d 586, 589 (5th Cir. 1987). Insofar as
letters of credit embody obligations between the issuer and
beneficiary, such contractual rights and duties are entirely
separate from the debtor’s estate:
[A]n issuer’s obligation to the letter of
credit’s beneficiary is independent from any
obligation between the beneficiary and the
issuer’s customer. All a beneficiary has to
do to receive payment under a letter of credit
is to show that it has performed all the
duties required by the letter of credit.
Id. at 590 (emphasis added). The structure of this relationship
between the beneficiary (EOP), issuer (Bank), and issuer’s customer
(Stonebridge) is referred to as the “independence principle.”
By its terms, § 502(b) applies only to claims against the
bankruptcy estate.7 See, e.g., In re Ska! Design, Inc., 308 B.R.
777, 781 (Bankr. N.D. Tex. 2004) (“Section 502 deals only with
7
EOP first raised this argument in its reply brief in
support of its motion for summary judgment in the bankruptcy court.
See 4 R. at 678 (“In this case, EOP did not make a claim against
the Debtor’s estate. The 502(b)(6) cap only applies for claims
against the estate. Thus, EOP did not have to take the cap into
consideration in calculating its damages.”). In the district court
proceedings, EOP specifically devoted an entire subsection of its
brief to this argument. See 1 R. at 47-48 (“When a creditor has a
claim against a third party arising out of the actions of the
debtor, or the creditor’s relationship with a debtor, the creditor
is not obligated to file a claim against the debtor’s estate to
pursue its remedy against a third party non-debtor.”). This
argument was reiterated in the appellant’s briefs to this court,
which described this proposition as “axiomatic” to the application
of § 502(b)(6). Brief of Appellant at 33; see also Reply Brief of
Appellant at 4-5. Because the record clearly demonstrates that EOP
adequately briefed and preserved this argument throughout the lower
court proceedings, we find no compelling reason to deem it waived
on this appeal. See Dial One of the Mid-South, Inc. v. BellSouth
Telecomms., Inc., 401 F.3d 603, 607 (5th Cir. 2005).
14
allowance by a landlord of a claim, if presented, against the
bankruptcy estate.”) (quoting In re Mr. Gatti’s, Inc., 162 B.R.
1004 (Bankr. W.D. Tex. 1994) (emphasis added). Claims under §
502(b) are not automatically assumed simply because the debtor
assumes or rejects a lease under § 365, but rather must be formally
filed against the estate in the bankruptcy court. See In re
National Gypsum Co., 208 F.3d 498, 505 (5th Cir. 2000) (finding
that the “opportunity” to file a proof of claim arises only
“subsequent to the debtor’s decision on how to treat the contract
or lease”); In re Austin Dev. Co., 19 F.3d 1077, 1085 (5th Cir.
1994) (finding that assumption or rejection of a lease simply
entitles lessor to then file a proof of claim). Stated simply, the
claim of a lessor against the assets of the estate is an essential
precondition to applying the damages cap at all. See In re Arden,
176 F.3d 1226, 1229 (9th Cir. 1999) ([Section 502(b)(6)] has two
predicates: ‘claim of a lessor’ and ‘damages resulting from the
termination of a lease or real property.’”). Thus, the damages cap
of § 502(b)(6) does not apply to limit the beneficiary’s
entitlement to the proceeds of the letter of credit unless and
until the lessor makes a claim against the estate.8 We find,
therefore, that further inquiry into the appropriate interpretation
8
We also note that § 502(b)(6) does not apply to limit
administrative expense claims made by the landlord based upon the
continued use of the premises after the filing of the bankruptcy
petition. See 4 COLLIER ON BANKRUPTCY ¶ 501.01[7][g] (15th ed. rev.
2005). Thus, this court will not imply a claim for lease-rejection
damages in EOP’s motion for administrative rent payments.
15
of § 502(b)(6) is unnecessary in this case because EOP did not file
a claim against the estate.
Nonetheless, Stonebridge argues that the bankruptcy court
reached the correct conclusion by limiting EOP to the capped
amount.9 Stonebridge asserts that the Letter of Credit is part of
the Security Deposit under the Lease, thus bringing it within the
purview of the § 502(b)(6) damages cap. In essence, Stonebridge
argues that landlords may not offset actual damages against their
security deposit and then claim for the balance under § 502(b)(6).
Security deposits “will be applied in satisfaction of the claim
that is allowed under [§ 502(b)(6)].” H.R. Rep. No. 95-595, at
353-55. To the extent that a landlord has a security deposit in
excess of the amount of his claim under § 502(b)(6), Stonebridge
asserts that the excess returns to the bankruptcy estate.
One problematic aspect of this argument is that it converts
§ 502(b)(6) into a self-effectuating avoiding power that would
allow the trustee to bring an adversary proceeding against a lessor
who exercises his rights under a letter of credit. This departs
from the plain language of § 502(b)(6), which “allows only one
thing--disallowance of the filed claim to the extent that it
exceeds the statutory cap.” Laura B. Bartell, The Lease Cap and
Letters of Credit: A Reply to Professor Dolan, 120 BANKING L.J. 828,
9
It is undisputed that EOP would have been limited to
rejection damages from Stonebridge’s estate of $1,353,032.02 under
§ 502(b)(6) if it had filed a claim against the estate.
16
835-36 (2003) (“Unlike preference law, there is no provision of the
Bankruptcy Code that allows the trustee to sue a lessor for
receiving property, even property of the estate, merely because it
exceeds the lease cap of Section 502(b)(6).”). When the Bankruptcy
Code intends to create an avoidance power, it does so expressly in
the language of the provision. See, e.g., 11 U.S.C. § 547(b); see
also Union Bank v. Wolas, 502 U.S. 151 (1991) (interpreting the
scope of a trustee’s avoidance powers provided under § 547).
Stonebridge’s argument draws an implicit analogy between the power
of trustees to avoid certain preferential transfers for the benefit
of the estate and the statutory cap imposed on a lessor’s lease-
rejection damages claim under § 502(b)(6) that simply cannot be
squared with language in the Bankruptcy Code.
Moreover, Stonebridge relies on two cases from other circuits
that have treated the proceeds of a letter of credit as a security
deposit and capped by § 502(b)(6): Solow v. PPI Enterprises, Inc.
(In re PPI Enterprises, Inc.), 324 F.3d 197 (3d Cir. 2003), and
Redback Networks, Inc. v. Mayan Networks Corp. (In re Mayan
Networks Corp.), 306 B.R. 295 (B.A.P. 9th Cir. 2004). In both
cases, however, the landlord filed a claim against the bankruptcy
estate seeking lease-rejection damages in excess of the amount of
the security deposit. Thus, the Trustee’s reliance on these two
cases is misplaced, because the record conclusively demonstrates
that EOP never filed a proof of claim against the Stonebridge
estate.
17
In sum, § 502(b)(6) does not alter the entitlement of EOP to
the full proceeds of the Letter of Credit in the case where EOP has
not also filed a claim against the estate for recovery of unpaid
lease monies. The bankruptcy court’s conclusion to the contrary
was in error.
2
We next examine the claims against EOP for prematurely drawing
against the Letter of Credit. The district court affirmed the
bankruptcy court’s holding that EOP breached the Lease and made
negligent misrepresentations to the Bank by drawing down on the
Letter of Credit prior to an event of default. The Lease provides:
Landlord may, from time to time, without
prejudice to any other remedy, use all or a
portion of the Security Deposit to satisfy
past due rent or to cure any uncured default
by Tenant.
The Lease further defines the following as events of default:
A. Tenant’s failure to pay when due all or any
portion of the Rent, if the failure continues
for 5 days after written notice to Tenant
(“Monetary Default”).
B. Tenant’s failure (other than Monetary
Default) to comply with any term, provision or
covenant of this Lease, if the failure is not
cured within 20 days after written notice to
Tenant . . . .
C. Tenant or any Guarantor becomes insolvent,
makes a transfer in fraud of creditors or
makes an assignment for the benefit of
creditors, or admits in writing its inability
to pay its debts when due. . . .
(a)
18
EOP asserts three separate reasons that it was entitled to the
full proceeds of the Letter of Credit at the time of the draw.
First, EOP argues that it did not prematurely draw down on the
Letter of Credit because Stonebridge was in Monetary Default when
EOP initiated the draw on the Letter of Credit. EOP contends that
its motion to compel payment of unpaid post-petition rent filed
seven days prior to EOP’s initiation of the draw on the Letter of
Credit (and served on Stonebridge’s attorneys) provided written
notice of Stonebridge’s past due rent. Furthermore, Stonebridge
acknowledged that it was in Monetary Default when it agreed that
EOP was owed pre- and post-petition rent as of the rejection date.
EOP contends that it was entitled to the proceeds of the Letter of
Credit to cure Stonebridge’s Monetary Default.
EOP also argues that it was entitled to the proceeds of the
Letter of Credit because Stonebridge triggered the Insolvency
Clause. Although 11 U.S.C. § 365(e)(1) prohibits the enforcement
of such ipso facto clauses against the debtor, EOP argues that its
ability to enforce its rights in the Lease against a third party
letter of credit issuer is not affected by the Bankruptcy Code.
Accordingly, at the time that the draw was initiated, EOP exercised
its rights against the Bank under a current default and therefore
did not prematurely draw on the Letter of Credit.
Finally, EOP maintains that it was entitled to the proceeds of
the Letter of Credit as lease-rejection damages. EOP asserts that
the bankruptcy court’s November 8 entry of its nunc pro tunc order
19
approving rejection of the Lease effective as of October 1 makes
EOP’s draw on the Letter of Credit valid. Because the retroactive
order set the effective date of rejection at October 1, the draw in
late October, if in error, would have been cured.
On the other hand, Stonebridge asserts that EOP drew on the
Letter of Credit prior to any event of default entitling EOP to the
full amount of the Letter of Credit. Stonebridge argues: (1) that
there were no Monetary Defaults under the Lease that entitled EOP
to the full amount of the Letter of Credit; (2) that EOP was not
entitled to draw on the Letter of Credit based on Stonebridge’s
insolvency under 11 U.S.C. § 365(e)(1); (3) that the bankruptcy
court’s November 8 order did not retroactively authorize EOP’s draw
on the Letter of Credit; and (4) that the language of the Lease did
not give EOP the right to satisfy EOP’s rejection damages with the
proceeds of the Letter of Credit.
(b)
We have determined earlier that § 502(b)(6) was not triggered
in this case and did not, therefore, cap damages payable under the
Letter of Credit from the Bank to EOP. We now turn to the question
of whether other factors limited damages that EOP could claim under
the Letter of Credit. With the exception of the question of the
timing of the lease rejection under § 365(a) (which is a question
of interpreting the Bankruptcy Code and the orders issued
therewith), the resolution of this question is a matter of
interpreting the Lease. EOP’s draw on the Letter of Credit must be
20
supported by some provision of the Lease that rightfully entitles
EOP to represent to the Bank that such funds were “due and owing.”
We conclude that EOP was entitled to draw on the Letter of
Credit under the “Monetary Default” provision of the Lease. At the
time of the draw, we have no doubt that Stonebridge was in Monetary
Default under the terms of the Lease.10 To the extent that the
bankruptcy court held otherwise by stating that “Landlord EOP never
provided notice of monetary or nonmonetary default to Stonebridge,”
In re Stonebridge Technologies, 291 B.R. at 72, the bankruptcy
court’s conclusions are incorrect. The Lease clearly provides that
Stonebridge would be in Monetary Default if it failed to pay its
rent when due or any portion of the rent and failed to cure within
five days of written notice. EOP’s motion for payment of rent was
made on October 15, 2001, seven days before EOP actually drew on
the Letter of Credit and provided sufficient written notice to
Stonebridge that the Lease was in Monetary Default. See LA-Nevada
Transit Co. v. Marathon Oil Co., 985 F.2d 797, 800 (5th Cir. 1993)
(holding that a notice is effective if “sufficiently clear to
10
During the bankruptcy court proceedings, Matthew Koritz,
the litigation and government affairs counsel for EOP’s general
partner, testified that the determination of whether funds were
“due and owing” under the Lease at the time of the draw was based
upon Stonebridge’s failure to pay portions of pre- and post-
petition rent and intention to reject the Lease in full as part of
its liquidation plan. 8 R. at 1511-12. Based on the formula
provided in the acceleration clause of the Lease, EOP calculated
its actual rejection damages under the Lease at approximately $1.5
to $1.6 million. 8 R. at 1478. Stonebridge does not dispute this
figure.
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apprise the other party of the action being taken”). Thus, the
bankruptcy court clearly erred in finding that EOP never provided
adequate notice of Monetary Default to trigger its right to draw
upon the Letter of Credit.
Once the Lease was in Monetary Default, EOP became entitled to
seek remedies, including drawing down all or a portion of the
Security deposit, to cure that default under the terms of the
Lease. The Lease also contains an acceleration clause under which
Landlord may elect to receive as damages the
sum of (a) all Rent accrued through the date
of the termination of this Lease or Tenant’s
right to possession, and (b) an amount equal
to the total Rent that Tenant would have been
required to pay for the remainder of the Term
discounted to present value at the Prime Rate
. . . then in effect, minus the present fair
rental value of the Premises for the remainder
of the Term, similarly discounted, after
deducting all anticipated Costs of Reletting.
This clause provides a measurement of lease rejection damages that
the Lessor can utilize in the event of a default. In fact, the
measure used to calculate accelerated damages under the Lease is
the same measure that would be used to calculate the damage to a
lessor from the rejection of a lease when not applying the §
502(b)(6) cap. See 11 U.S.C. § 502(g) (“A claim arising from the
rejection . . . of an executory contract or unexpired lease of the
debtor that has not been assumed shall be determined . . . as if
such claim had arisen before the date of the filing of the
petition.”); City Bank Farmers Trust Co. v. Irving Trust Co., 299
U.S. 433, 443 (1937) (“The amount of the landlord’s claim for the
22
loss of his lease necessarily is the difference between the rental
value of the remainder of the term and the rent reserved, both
discounted to present worth.”); Kimberly S. Winick, Tenant Letters
of Credit; Bankruptcy Issues for Landlords and Their Lenders, 9 AM.
BANKR. INST. L. REV. 733, 761 (2001) (noting that the terms of the
lease agreement should be used to calculate damages when the
statutory cap of § 502(b)(6) is not involved). Applying this
formula in the instant case, EOP’s accelerated damages under the
Lease (estimated at between $1.5 and $1.6 million) exceeded the
value of the Letter of Credit ($1,430,065.74).
We find, therefore, that the proceeds of the Letter of Credit
were correctly applied to cover these accelerated damages. The
Lease provides that EOP could use “all or a portion of the Security
Deposit to satisfy past due Rent or to cure any uncured default by
Tenant.” The Letter of Credit, defined under the Lease as a
portion of the Security Deposit, may therefore be used to satisfy
past due rent or cure any uncured default. Because, in this case,
those accelerated damages exceed the value of the proceeds of the
Letter of Credit, EOP is entitled to the full proceeds of the
Letter of Credit to cure the uncured Monetary Default.
Finally, we reject the Trustee’s argument that the draw was
premature based on the fact that the bankruptcy court did not issue
its final order granting the administrative rent claims and setting
the effective lease rejection date until November 8. First, we
note that most courts have held that lease rejection may be
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retroactively applied. See In re Jamesway Corp., 179 B.R. 33, 37
(Bankr. S.D.N.Y. 1995) (“The majority of courts . . . have held
that the effective date of rejection is the date of the bankruptcy
court’s order approving rejection, and that court approval is a
condition precedent to effective rejection.”). Moreover, the
parties’ announcement in open court on October 23 clearly evinced
Stonebridge’s preference for an earlier effective rejection date,
which ended up saving the estate over $200,000 in administrative
rent expenses. 8 R. at 1480. We are unwilling to allow
Stonebridge to reap the benefits of the retroactive order without
also recognizing that the earlier date effectively cured the
prematurity of EOP’s draw request on the Letter of Credit. See
Browning v. Navarro, 743 F.2d 1069, 1081 (5th Cir. 1984) (applying
basic rules of contract interpretation to preserve the intended
compromise reached by the parties under the terms of an agreement
approved by the bankruptcy court).
Accordingly, EOP did not breach the Lease or negligently
misrepresent to the Bank that sums were “due and owing” by drawing
the full amount of the Letter of Credit.
III
Thus, we hold that the bankruptcy court has general and core
jurisdiction over the claims for breach of the Lease and negligent
misrepresentation brought by the Trustee. Finding jurisdiction, we
hold that § 502(b)(6) does not apply to cap the proceeds that EOP
may claim against the Letter of Credit because EOP never filed a
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claim for damages against the Stonebridge estate. Further, we hold
that the acceleration clause of the Lease permitted the draw on the
proceeds of the Letter of Credit by EOP when Stonebridge defaulted
on its rent payments. Consequently, there was no breach of the
Lease or misrepresentation to the Bank.
For the foregoing reasons, the judgment of the district court
affirming the judgment of the bankruptcy court in this adversary
proceeding is REVERSED, and the case is REMANDED to the district
court for further proceedings consistent with this opinion.
REVERSED and REMANDED.
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EOP-Colonnade of Dallas Ltd. Partnership v. Faulkner
Court: Court of Appeals for the Fifth Circuit
Date filed: 2005-11-08
Citations: 430 F.3d 260
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