Abboud v. Ground Round, Inc. (In Re Ground Round, Inc.)

United States Court of Appeals
For the First Circuit

No. 06-9002

IN RE: THE GROUND ROUND, INC.,

Debtor.
__________

JOSEPH A. ABBOUD, ELIAS N. DOW, WAZEN J. WYZEW,
a Pennsylvania Partnership, and BYBLOS, INC.,

Appellees,

v.

THE GROUND ROUND, INC.,

Appellant.

APPEAL FROM THE BANKRUPTCY APPELLATE PANEL

FOR THE FIRST CIRCUIT

Before

Boudin, Chief Judge,

Campbell, Senior Circuit Judge,

and Lipez, Circuit Judge.

Harold B. Murphy with whom Andrew G. Lizotte, Christian J.
Urbano and Hannify & King, P.C. were on brief for appellant.
Eugene J. Malady for appellees.

March 30, 2007
 BOUDIN, Chief Judge. In 1977, Joseph Abboud and several

partners (collectively, "the partnership") leased real property in

West Chester, Pennsylvania, to the Howard Johnson Company for use

as a restaurant. The lease was for 10 years, with options to the

lessee to extend for six periods of five years each. The Ground

Round, Inc. ("Ground Round") later succeeded Howard Johnson as the

lessee of the premises.

In 1978, a Pennsylvania liquor license for use at the

same premises was obtained in the name of one of the lessor

partners (a corporation), and title to the license was in turn

transferred to Ground Round. This was contemplated by an addendum

to the initial lease which pertinently provided:

Lessor shall transfer to Lessee in
consideration of this Lease and One ($1)
Dollar, the liquor license of Lessor at the
demised premises, which is a full-service
restaurant license with Sunday Sales Permit .
. . . At the termination of the Lease, Lessee
shall, in consideration of this Lease and One
($1) Dollar transfer such liquor license to
Lessor free of all claims or violations . . .
.

In early 2004, while operating under the extended lease,

Ground Round filed for bankruptcy under chapter 11 of the

Bankruptcy Code, 11 U.S.C. § 101 et seq. (2000), and ceased to

operate its restaurant at the leased premises. Thereafter, Ground

Round as debtor in possession rejected the lease, as a debtor may

do with an executory contract, id. § 365, claiming as well the

right to retain the liquor license.

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 The partnership then began an adversary proceeding

against the debtor, seeking specific performance of the lease

provision (quoted above) requiring return of the license at the end

of the lease. The bankruptcy judge granted this relief and the

Bankruptcy Appellate Panel affirmed. In re The Ground Round, Inc.,

326 B.R. 23 (Bankr. D. Mass. 2005), aff'd, 335 B.R. 253 (B.A.P. 1st

Cir. 2005). Ground Round now appeals to this court. The issues

are questions of law which we review de novo. In re DN Assocs., 3

F.3d 512, 515 (1st Cir. 1993).

Under the Bankruptcy Code the debtor's estate includes

"all legal or equitable interests of the debtor in property as of

the commencement of the case." 11 U.S.C. § 541(a)(1). The section

is construed broadly, United States v. Whiting Pools, Inc., 462

U.S. 198, 204-05 & n.9 (1983), and the meaning of the quoted phrase

is a matter of federal law; but the existence and extent of the

debtor's interest is ordinarily a creature of state law. Butner v.

United States, 440 U.S. 48, 54-55 (1979); see also 1 Queenan et

al., Chapter 11 Theory and Practice § 9.07 (1994).

At the threshold, the partnership claims that the liquor

license was not an interest of the debtor in property so that the

license cannot belong to the estate. The partnership argues that

when the lease was executed, the Pennsylvania Liquor Code made

clear that a liquor license was considered "a personal privilege"

and not "property." 47 Pa. Stat. Ann. § 4-468(b.1) (1977); see

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also 1412 Spruce, Inc. v. Pa. Liquor Control Bd., 474 A.2d 280, 283

(Pa. 1984). The state code was amended in 1987--after the

effective date of the lease--to make a liquor license property as

between the licensee and third parties. 47 Pa. Stat. Ann. § 4-

468(d) (2006). But the license would be a property interest within

section 541(a)(1) even if the amendment had never been adopted.

"The label . . . that state law affixes to a particular

interest in certain contexts is not always dispositive. The

principal question is whether the substance of the right or

interest in question brings it within the scope of estate property

under the Bankruptcy [Code]." In re Nejberger, 934 F.2d 1300, 1302

(3d Cir. 1991). Under Pennsylvania law even before the amendment,

such licenses were transferable items having substantial monetary

value. 47 Pa. Stat. Ann. § 4-468(a)(1) (1977); 21 West Lancaster

Corp. v. Main Line Rest., Inc., 790 F.2d 354, 357 (3d Cir. 1986).

The fact that agency or other third-party approval is

required for a transfer does not take the interest outside section

541's language or its policy; broadcast licenses and condominiums

are common examples. As the Seventh Circuit said in In re Barnes,

276 F.3d 927, 928 (7th Cir. 2002), "the few cases to address the

issue hold that a liquor license, provided it is salable, is indeed

property within the meaning of section 541 of the Bankruptcy Code."

Accord In re Nejberger, 934 F.2d at 1302 (addressing Pennsylvania

liquor license).

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 This is not the end of the story. With a few exceptions,

"[a] bankruptcy estate cannot succeed to a greater interest in

property than the debtor held prior to bankruptcy." In re NTA,

LLC, 380 F.3d 523, 528 (1st Cir. 2004); see also 11 U.S.C. §

541(d). What Ground Round had at the point of bankruptcy was legal

title to the license, the right to retain and enjoy its benefits

during the real estate lease, and an obligation to restore the

license to the partnership at the end of the lease.

Ground Round's rejection of the lease did not terminate

Ground Round's title to the license, but it did end its right under

the contract to continued use of the license and left the

partnership with ordinary remedies for breach of contract. See 11

U.S.C. § 365(g). Under state law, specific performance would

normally be available to retrieve the license for the partnership

even before the amendment. Cochrane v. Szpakowski, 49 A.2d 692,

694 (Pa. 1946); Tomb v. Lavalle, 444 A.2d 666, 668 (Pa. Super. Ct.

1981).

On this appeal, Ground Round argues that the contractual

obligation to return the license vanished when it rejected the

lease and that allowing specific performance would undercut the

rejection power. The law is in remarkable confusion on this issue.

Some judges think that enforcing the turnover of property would

mimic the rejected contractual obligation, thereby undercutting the

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rejection power itself, and that only money damages are permitted;1

to others, and especially the commentators who criticize the former

decisions, a specific performance right to property under state law

is left undisturbed and should be enforced–-unless the Bankruptcy

Code otherwise bars this outcome.2

The Code does not directly address this problem.

Congress has sought solutions to specific applications, expressing

sympathy for enforcement in certain cases with qualifications, see

11 U.S.C. §§ 365(i); 365(j); 365(n); 1113, but this can be taken

both ways: either as creating exceptions to a non-enforcement

principle or as a tendency toward the opposite broader principle of

enforcement. We see no need here to attempt an overall solution;

indeed, a bright-line solution may be a bad answer.

Where a claimant holds something akin to a property right

in something held by the debtor, that right survives bankruptcy and

1
E.g., Midway Motor Lodge of Elk Grove v. Innkeepers'
Telemanagement & Equip. Corp., 54 F.3d 406, 407 (7th Cir. 1995); In
re Richmond Metal Finishers, Inc., 756 F.2d 1043, 1048 (4th Cir.
1985). A now elderly First Circuit case could be read as assuming
this view, but the contract there specified performance or a return
of escrow (which the court ordered). See Gulf Petro., S.A. v.
Collazo, 316 F.2d 257, 260 (1st Cir. 1963).
2
Westbrook, A Functional Analysis of Executory Contracts, 74
Minn. L. Rev. 227, 257, 260-61, 269, 336 (1989); Andrew, Executory
Contracts in Bankruptcy: Understanding "Rejection," 59 U. Colo. L.
Rev. 845, 906-11 (1988); see also In re Bergt, 241 B.R. 17 (Bankr.
D. Alaska 1999); In re Walnut Assocs., 145 B.R. 489, 494 (Bankr.
E.D. Pa. 1992); In re Drexel Burnham Lambert Group, Inc., 138 B.R.
687, 709 (Bankr. S.D.N.Y. 1992); cf. Jackson, The Logic and Limits
of Bankruptcy Law 108-13 (1986).

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remains enforceable to recover the property from the estate,3

except where that right is cut off by provisions of the Bankruptcy

Code.4 The nature of an interest under the Code is determined by

state law. Butner, 440 U.S. at 54-55. Under Pennsylvania law, the

partnership's interest in the license is pretty close to that of a

lessor, see O'Neill v. Keegan, 103 A.2d 909, 910-11 (Pa. 1954), and

was likely framed in terms of a transfer and re-transfer solely

because state law did not permit a lease.

Ground Round counters that because the liquor license

could not be leased at the time that the transfer was made, the

sale coupled with the re-purchase provision constituted an illegal

attempt to circumvent Pennsylvania law. It then argues that a

Pennsylvania court would not order specific performance of an

3
See 11 U.S.C. § 541(d); Whiting Pools, 462 U.S. at 205 n.10;
see also Conn. Gen. Life Ins. Co. v. Universal Ins. Co., 838 F.2d
612, 618 (1st Cir. 1988); 1 Queenan et al., Chapter 11 Theory and
Practice § 9.20. See generally In re Lavigne, 114 F.3d 379, 387
(2d Cir. 1997) ("[T]he Code does not determine parties' rights
regarding the contract and subsequent breach. To determine these
rights, we must turn to state law.").
4
Some courts have held that a nondebtor's equitable interest
can never be cut off by the trustee due to the operation of section
541(d). See In re Quality Holstein Leasing, 752 F.2d 1009, 1013
(5th Cir. 1985). Other courts disagree and hold that,
notwithstanding section 541(d), the trustee may be able to use his
strong-arm powers under section 544(a) to extinguish a nondebtor's
equitable interest if the debtor held title. See Belisle v.
Plunkett, 877 F.2d 512, 515 (7th Cir. 1989). We need not take a
position on this issue, but assume arguendo that the trustee's
strong-arm powers can extinguish a nondebtor's equitable interest.

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unlawful contract and that the partnership would be "estopped in

Pennsylvania courts from enforcement of this equitable relief."

Although a court may refuse to enforce an illegal

contract, Ground Round makes no effort to show that a Pennsylvania

court would regard the re-transfer clause as unlawful. After all,

both the initial and re-transfer are subject to regulatory

approval. See 47 Pa. Stat. Ann. § 4-468(a)(1). And, if the

arrangement were unlawful, perhaps it would invalidate the original

transfer and not just the re-transfer. See Davis v. Pittsburgh

Nat. Bank, 548 A.2d 1326, 1329 (Pa. Commw. Ct. 1988).

As for estoppel, Ground Round was complicit in the

arrangement. The company does not point to evidence of the

conventional estoppel elements of representation and reliance. See

Novelty Knitting Mills, Inc. v. Siskind, 457 A.2d 502, 503-04 (Pa.

1983). Presumably, if the lease had terminated without bankruptcy,

Pennsylvania courts would have enforced the contractual re-transfer

if Ground Round had refused to do it.

The more serious arguments by Ground Round depend solely

on the Bankruptcy Code. The first is based on section 101(5), 11

U.S.C. § 101(5), which defines what is a "claim" for

dischargeability and other purposes under the Bankruptcy Code; and

arguably the partnership's request for specific performance does

fall within this definition. The term "claim" is defined by

section 101(5) to mean either:

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 (A) right to payment, whether or not
such right is reduced to judgment, liquidated,
unliquidated, fixed, contingent, matured,
unmatured, disputed, undisputed, legal,
equitable, secured, or unsecured; or

(B) right to an equitable remedy for
breach of performance if such breach gives
rise to a right to payment, whether or not
such right to an equitable remedy is reduced
to judgment, fixed, contingent, matured,
unmatured, disputed, undisputed, secured, or
unsecured.

The BAP, in an attempt to classify the interest as

something other than a "claim," said tersely that under

Pennsylvania law specific performance was available because the

license is regarded as unique and that therefore the breach did not

give rise to a right to payment under subsection (B). In re Ground

Round, 335 B.R. at 261-63. The premise is correct, but the

conclusion does not follow. The failure to return the license

would give rise to a damage claim as an alternative to specific

performance,5 so arguably subsection (B) would class this equitable

remedy as a claim.

However, Ground Round has provided no reason why

classification as a "claim" matters. One must hold a "claim" in

order to seek a share of remaining estate assets in a final

distribution, and a "claim" is what is discharged when the

5
See Trachtenburg v. Sibarco Stations, Inc., 384 A.2d 1209,
1211-12 (Pa. 1978); Hawley Bank v. Santini, 389 A.2d 671, 672-73
(Pa. Super. Ct. 1978); see also 5 Corbin on Contracts § 1001
(1964), as quoted by 3 Queenan et al., Chapter 11 Theory and
Practice § 21.06.

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bankruptcy terminates. See 3 Epstein et al., Bankruptcy, § 11-1,

at 70-71 (1992). But the partnership is not seeking a share of

remaining assets but a return of specific property; and no one is

seeking to impose post-discharge obligations on Ground Round.

Ground Round may think that the holder of a claim can

never seek a return of property because this would violate the

principle of equal treatment of creditors; but in fact secured

creditors regularly get back secured property or its equivalent to

pay their claims. E.g., In re Carvalho, 335 F.3d 45, 47 (1st Cir.

2003). That one has a claim does not automatically foreclose a

demand for specific property if state law recognizes the interest

and the Bankruptcy Code does not disallow it.6

Arguing for disallowance under the Code, Ground Round

relies on section 544, 11 U.S.C. § 544(a)(1). For our purposes the

key language of section 544 is as follows:

The trustee shall have, as of the
commencement of the case . . . the rights and
powers of . . . a creditor that extends credit
to the debtor at the time of the commencement
of the case, and that obtains, at such time
and with respect to such credit, a judicial
lien on all property on which a creditor on a

6
See Andrew, supra, at 926-27 ("The non-debtor may or may not
have a claim for the debtor's breach of contract . . . and that
claim may or may not be dischargeable, but those issues simply do
not relate to the question whether the non-debtor has a right in or
to the property itself."); 2 Epstein et al., Bankruptcy, § 7-10, at
300 ("The bankruptcy has no effect [on a secured claim] because
bankruptcy honors the property principle of derivative title, and
the lienor's interest in the debtor's property is excluded from the
bankruptcy estate.").

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 simple contract could have obtained such a
judicial lien, whether or not such a creditor
exists.

Section 544 invokes state law–-here, Pennsylvania's law--

to determine the rights of the hypothetical lien creditor. See In

re Hilde, 120 F.3d 950, 952 (9th Cir. 1997). And, under state law

as it stood when the lease was made, it appears that a contract-

claim litigant could not have obtained a lien on the liquor

license. See 1412 Spruce, 474 A.2d at 283; In re Revocation of

Liquor License No. R-2193, 456 A.2d 709, 711 (Pa. Commw. Ct. 1983).

By contrast, the later amended statute would permit such

liens and would also permit a security interest to be created in

the license by its owner to secure an obligation to a third party.7

Accordingly, if the whole transaction was to occur anew today, the

hypothetical lien creditor in section 544(a) might well have

priority today over a party with the interest in the license held

by the partnership, which we will assume arguendo but need not

decide.

Thus, everything comes down to whether pre-amendment or

post-amendment law governs in determining the rights of the

hypothetical lien creditor. Pennsylvania courts follow the common

practice of avoiding retroactivity in civil statutes unless the

7
See 47 Pa. Stat. Ann. § 4-468(d); In re J.B. Winchells, Inc.,
106 B.R. 384, 391-92 (Bankr. E.D. Pa. 1989). In fact, state tax
authorities supported the amendment so that they could "execut[e]
on licenses held by delinquent taxpayers." In re Pompeo, 195 B.R.
43, 47 n.5 (Bankr. W.D. Pa. 1996).

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statute specifies otherwise, 1 Pa. Cons. Stat. § 1926; accord

Stroback v. Camaioni, 674 A.2d 257, 260 (Pa. Super. 1996); but how

to apply this rubric is debatable. The lease was made prior to the

statute; the bankruptcy and the specific performance claim are

being made post-amendment.

Although the issue was not extensively briefed, we think

applying the amendment in this case would undermine reasonable

expectations. True, once the amendment was passed, the partnership

was apprised that the license could now be attached; but the

partnership was no longer in a position to protect itself by

insisting on getting an explicit security interest in the license

from Ground Round, as it could have done if the amendment had

occurred early in 1977.

One might ask whether this outcome would be fair to

someone who lent money to Ground Round, believing that Ground Round

owned the license outright; but no such person has appeared, nor

does the Bankruptcy Code protect every case of lender reliance.

Retroactivity questions tend to be fact-specific and we have made

our best guess as to how a Pennsylvania court would rule as to the

retroactivity issue.

If Pennsylvania law permitted a lease of the license,

that is likely what the parties would have done; and then--when

Ground Round rejected the lease--any right Ground Round held in the

license would automatically have expired. The formal structure of

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a bona fide transaction is not lightly to be disregarded in

bankruptcy. See In re Lazarus, No. 06-1982, 2007 U.S. App. LEXIS

388 (1st Cir. Jan. 9, 2007). But an outcome that mimics this

underlying reality has something in its favor.

Affirmed.

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