Koenig Sporting Goods Inc. v. Morse Road Co. (In Re Koenig Sporting Goods Inc.)

1999 FED App. 0004P, 229 B.R. 388, 41 Collier Bankr. Cas. 2d 724, 1999 Bankr. LEXIS 108, 1999 WL 68611

• Court: Bankruptcy Appellate Panel of the Sixth Circuit
• Decided: February 16, 1999
• Docket: BAP 98-8055
• Status: Published

Opinions

OPINION

The bankruptcy court, interpreting 11 U.S.C. § 365(d)(3), held that the Debtor’s landlord was entitled to a full month’s rent when the Debtor rejected a nonresidential lease and vacated the property on the second day of the month. We agree and affirm.

I.ISSUE ON APPEAL¹

Whether 11 U.S.C. § 365(d)(3) requires a debtor that rejects a nonresidential lease on December 2 to pay in full one month’s rent that became due on December 1.

II.JURISDICTION AND STANDARD OF REVIEW

The United States District Court for the Northern District of Ohio has authorized appeals to the BAP. The bankruptcy court’s order requiring the Debtor to pay one month’s rent under § 365(d)(3) is a final appealable order. See In re Handy Andy Home Improvement Ctrs., Inc., 144 F.3d 1125 (7th Cir.1998). Interpretation of § 365(d)(3) is a question of law reviewed de novo. Andersson v. Security Fed. Savs. & Loan (In re Andersson), 209 B.R. 76, 77 (6th Cir. BAP 1997).

III.FACTS

Koenig Sporting Goods, Inc. (“Koenig” or “Debtor”) operated retail sporting good stores in leased spaces in shopping centers. Koenig filed Chapter 11 in August of 1997. It sold many locations during the Chapter 11 case and, after liquidating inventory, rejected leases at its remaining stores. Morse Road Company was the landlord for a rejected lease.

Rejection of the Morse Road lease was effective on December 2, 1997. The Debtor vacated the property that day.

According to the lease, monthly rent of $8,500 for December 1997 became due on December 1, 1997. This rent was “payable in advance on the first (1st) day of each and every calendar month.” (App. at 8) (Lease Agreement Between Morse Road Co. and Koenig Sporting Goods, Inc. at ¶ 5(a)).

Morse Road demanded payment of $8,500 for the month of December, citing 11 U.S.C. § 365(d)(3). The Debtor responded that it was in possession for only two days in December 1997 and the rent should be prorated, producing a recovery of approximately $550.

The bankruptcy court thoughtfully analyzed the conflicting case law interpreting § 365(d)(3) and concluded that “section 365(d)(3) was, at the least, intended to assure the landlord payment of ordinary monthly rent payments which become due during the postpetition prerejection period.” In re Koenig Sporting Goods, Inc., 221 B.R. 737, 740-41 (Bankr.N.D.Ohio 1998). The bankruptcy court acknowledged that requiring the Debt- or to pay a full month’s rent for December “would impinge to some extent upon normal bankruptcy principles and priorities,” but concluded that this dissonance was compelled by the choices Congress made when it enacted § 365(d)(3) in 1984 to protect nonresidential landlords from debtors in bankruptcy. Id. at 741. The bankruptcy court reserved the possibility that on other facts § 365(d)(3) might require “some discretion” to avoid “severe[ ] distortion of] fundamental bankruptcy principles.” Id.

The Debtor timely appealed.

IV. DISCUSSION

The plain language of § 365(d)(3) fully supports the bankruptcy court’s conclusion that the Debtor must pay one month’s rent that became due under its lease on December 1, 1997. Section 365(d)(3) provides:

The trustee shall timely perform all the obligations of the debtor, except those specified in section 365(b)(2), arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title.

11 U.S.C. § 365(d)(3).

The Morse Road lease is typical in its requirement that the Debtor pay rent in advance on the first day of each month. The requirement to pay one month’s rent on December 1 was an “obligation of the debtor” that arose after the order for relief and (one day) before the lease was rejected. Writing on a clean slate, we would prudently end our analysis with this plain language application of § 365(d)(3).

The slate, however, is hardly clean. The bankruptcy court succinctly summarized the many reported decisions interpreting § 365(d)(3):

There is a conflict in the cases as to whether section 365(d)(3) compels a debtor to pay all rent and other charges which become due under a lease during the post-petition prerejection period or whether, instead, it requires the debtor to pay only the rent and charges allocable to that period. Compare Santa Ana Best Plaza, Ltd. v. Best Prods. Co. (In re Best Prods. Co.), 206 B.R. 404, 406 (Bankr.E.D.Va.1997), with In re Krystal Co., 194 B.R. 161, 163 (Bankr.E.D.Tenn.1996).... [T]he courts have framed the issue as whether section 365(d)(3) by its terms clearly compels the debtor to pay in full obligations becoming due postpetition but prerejection, even though allocable to another time period, or whether its terms are sufficiently malleable to permit the court to construe them to require payment only of rent and other charges allocable to the postpetition prere-jection period.

Koenig Sporting Goods, 221 B.R. at 738.

Although the cases do not divide perfectly, the two approaches to § 365(d)(3) can be described as the Accrual (Allocation/Pro-ration) Approach (majority) and the Billing Date Approach (minority).

A statement of the Billing Date Approach would be that any amount coming due under a lease in the postpetition, prerejection period must be paid in full by the debtor without regard to whether the payment pertains to a prepetition or postrejection benefit. Decisions that adopt the Billing Date Approach include Inland’s Monthly Income Fund, L.P. v. Duckwall-ALCO Stores, Inc. (In re Duckwall-ALCO Stores, Inc.), 150 B.R. 965 (D.Kan.1993) (holding that § 365(d)(3) is clear and unambiguous in requiring that the debtor comply with all obligations arising under the lease after the petition); In re Krystal Co., 194 B.R. 161, 163 (Bankr.E.D.Tenn.1996) (holding a plain reading of § 365(d)(3) precludes an accrual and pro-ration analysis); In re F & M Distribs., Inc., 197 B.R. 829, 832 (Bankr.E.D.Mich.1995) (“[B]ecause § 365(d)(3) is unambiguous, this Court must follow its plain language without regard to any equitable or policy considerations.”); and In re Appletree Markets Inc., 139 B.R. 417, 420 (Bankr.S.D.Tex.1992) (“[T]he plain meaning of Section 365(d)(3) provides for payment of obligations arising after the petition is filed, not before.”).

Under the Accrual Approach, a debtor is required by § 365(d)(3) to pay only those sums coming due under a lease during the postpetition, prerejection period that pertain to benefits realized by the estate during that period. Under the Accrual Approach a debt- or is not required to pay for any benefit conferred before the petition is filed or after rejection occurs regardless of when the payment for that benefit became due under the lease. Decisions adopting some form of the Accrual Approach include Newman v. McCrory Corp. (In re McCrary Corp.), 210 B.R. 934, 940 (S.D.N.Y.1997) (“[T]he debtor-tenant’s obligations under the lease to pay real estate taxes accrues on a daily basis and ..., under § 365(d)(3), postpetition bills must be prorated so that the debtor only pays those charges accruing during the postpetition, prerejection period.” (footnote omitted)); Child World, Inc. v. Campbell/Massachusetts Trust (In re Child World, Inc.), 161 B.R. 571, 576 (S.D.N.Y.1993) (holding § 365(d)(3) only requires timely payment of lease obligations billed during the postpetition, prerejection period, that actually cover the postpetition, prerejection period); In re Victory Markets, Inc., 196 B.R. 6 (Bankr.N.D.N.Y.1996) (adopting Accrual Approach and finding that § 365(d)(3) is ambiguous in context of a lease obligation to reimburse a landlord for real estate taxes); In re Almac’s, Inc., 167 B.R. 4, 8 (Bankr.D.R.I.1994) (addressing “the appropriate formula for determining when a tax obligation arises, for purposes of payment under § 365(d)(3)”); and In re Revco D.S., Inc., 111 B.R. 626, 629 (Bankr.N.D.Ohio 1989) (“Ail percentage rent earned from the beginning of the bankruptcy administration to the end of the Lease year should be paid as .... a postpetition expense of the Debtors’ estate [under § 365(d)(3).]” No portion relating to the prepetition period is allowed under § 365(d)(3).) See also Handy Andy, 144 F.3d at 1128 (adopting neither approach but holding that an “obligation to pay or reimburse the taxes that accrued prepetition is a prerather than post-petition obligation_ There is no indication that Congress meant to go any further than to provide a landlord exception to 503(b)(1), and thus no indication that it meant to give landlords favored treatment for any class of prepetition debts.”).

The argument for the Billing Date Approach was ably stated in Krystal Company:

The most natural reading of § 365(d)(3) leads to the conclusion that Congress meant to require payment of all the debt- or’s obligations falling due under its lease until such time as the debtor rejects the lease in question. Essentially the statute requires the debtor to “timely perform” its “obligations ... under any unexpired lease .... ” until the lease has been assumed or rejected. That language clearly includes tax reimbursement payments to the landlord if and when called for by the lease. The problem is caused by the additional language of the statute, “arising from and after the order for relief,” which modifies the word “obligations.” Courts adopting the accrual theory believe this language allows them to adhere to the pre-1984 (presection 365(d)(3)) practice of prorating taxes between the prepetition and prere-jection periods because they mistakenly assume that the “arising from” language of the statute means that the obligation must somehow arise from the prerejection period — that is, be an administrative expense — before the obligation is payable.

This court disagrees because other language within the statute, “notwithstanding section 503(b)(1) of this title,” directly precludes viewing such obligations as administrative expenses. The “notwithstanding” phrase means that the obligations in question are to be paid “in spite of’ the operation of § 503(b)(1), which would otherwise limit postpetition payments to those necessary for “preserving the estate.” Thus, these prerejection obligations are not to be viewed as administrative expenses, but as obligations to be “timely performfed]” under the lease. Moreover, since the payment of these obligations is not designed to preserve the estate (but rather the vulnerable landlord), the concepts of accrual, pro-ration and allocation — so necessary for distinguishing between prepetition debts and administrative expenses in the context of § 503(b)(1) — are irrelevant and inapplicable under § 365(d)(3).

That § 365(d)(3) was designed to protect the landlord rather than the estate by disarming § 503(b)(l)’s practices and procedures may be readily seen in the legislative history of § 365(d)(3).... [Remarks of Sen. Hatch reprinted below.]

Senator Hatch’s remarks avoid the confusing “arising from and after” language of § 365(d)(3) and significantly make no mention of the concepts of accrual or proration of charges. There is no mention of “actual or necessary” expenses as might be expected if § 503(b)(1) were still operative. There is only the categorical “timely performance requirement” as an antidote to the problems “caused ... by the administration of the bankruptcy code.” When read in conjunction with the statute as it must be, this “problem” language can only refer to § 503(b)(1), for that is the subsection specifically overridden by the amendment. Section 503(b)(l)’s essential concepts, accrual and proration, cannot be shown to have survived in § 365(d)(3), where they are unnecessary on a plain reading of the statute, and it makes no sense to force them.

The legislative solution to a problem need not necessarily be a perfect solution, and there are doubtless cases that can be imagined in which the court’s reading of the statute in question might produce dubious results, as where rent or some other lease obligation is payable in one yearly installment, or perhaps every several years. Actually, these situations are not nearly as serious as they might seem at first blush, and policy arguments based on supposed anomalous results ... overlook remedies already available in the Code.

From a reading of the statute and its legislative history, it appears that Congress specifically intended to except a tenant’s lease obligations to his landlord from the workings of the Code’s administrative expense provisions because Congress believed nonresidential landlords and their other solvent tenants were particularly vulnerable creditors under the old procedures. Rather than forcing the landlord to take the initiative, apply for, and wait for an administrative expense allowance, as it was required to do before 1984, Congress intended § 365(d)(3) to shift the burden of indecision to the debtor: the debtor must now continue to perform all the obligations of its lease or make up its mind to reject it before some onerous payment comes due during the prerejection period. That is a sensible adjustment of this particular debt- or-creditor relationship.

Krystal Co., 194 B.R. at 163-64 (internal citations omitted).

The rationale behind the Accrual Approach is fully stated in MeCrory:

While the term “obligation” itself may be unambiguous, the language of § 365(d)(3) simply does not answer the question at hand. The phrase “arising from and after the order for relief under any unexpired lease of nonresidential real property” is far from clear. Nor is it clear whether the phrase “until such lease is assumed or rejected” limits the “obligation” in question to those actually accruing before rejection. Accordingly, I find it useful to turn to the legislative history of § 365(d)(3), as well as the overall operation of the Code, for guidance in construing § 365(d)(3).

In recent cases interpreting the Bankruptcy Code, the Supreme Court has tempered its application of the plain meaning rule, particularly when it would effect a major change in practice under the Code as it existed at the time, unless there is support for such a change in the legislative history. As the Second Circuit has explained:

When Congress amends the bankruptcy laws, it does not write on a clean slate.... Furthermore, [the Supreme Court] has been reluctant to accept arguments that would interpret the Code, however vague the particular language under consideration might be, to effect a change in pre-Code practice that is not the subject of at least some discussion in the legislative history.

In re Klein Sleep Prods., Inc., 78 F.3d 18, 27 (2d Cir.1996) [ (citation omitted) ]; In re R.H. Macy & Co., Inc., 170 B.R. 69, 73 (Bankr.S.D.N.Y.1994) (“even within the fluctuating walls of the ‘plain meaning’ fortress a court should not resolve questions of statutory interpretation so that a particular Bankruptcy Code section conflicts and disturbs the overall purpose and function of the Code”) (citations omitted)[.]

Here, neither the language of the statute nor the legislative history reveals a Congressional intent to deviate from the pre-amendment practice of prorating lease obligations pending rejection, other than to require “current payment” for “current services.” Rather, “Congress enacted § 365(d)(3) to ensure that landlords would not be disadvantaged by providing post-petition services to the debtor. Put another way, Congress intended the subsection to put landlords on an equal footing, not to grant them a windfall at the expense of other creditors.” The approach followed by the [Billing Date] courts would drastically alter the priority and distribution scheme under the Bankruptcy Code.

Reliance strictly on the billing date would result in a windfall either to the landlord or to the debtor-tenant. A windfall would flow to the landlord here if McCrory were required to pay the 1996 real estate taxes in full, since the landlord would have recovered taxes for the coming year and could then relet the property and recover again fully or partially for those same tax bills. At the same time, McCro-ry would be required to pay a year’s worth of taxes even though it was only in possession for one month before the leases were rejected. On the other hand, a windfall would flow to the debtor-tenant where annual taxes for the coming year fell due one day before the petition is filed, and thus get paid pro-rata along with all other unsecured, pre-petition creditors. Neither scenario can be what Congress had in mind when it acted to ensure that landlords received timely payment for the services they were forced to provide pending assumption or rejection of the lease.

... There is no indication that Congress intended to modify pre-Code practice to eliminate proration under these circumstances, in light of any other remedies that might be available under the Code.

In contrast, the [Accrual Approach] appears to serve not only the interests of the debtor but those of the landlord and other creditors as well. The majority reasoning is particularly compelling, and the.shortcomings of the minority’s application of the plain meaning rule are especially evident, on the facts before me in this case. In addition, “[t]he bankruptcy court is essentially a court of equity ... [and it] applies the principles and rules of equity jurisprudence.”

McCrory, 210 B.R. at 939-40 (internal citations and footnotes omitted).

The historical setting mentioned in these quotes is that § 365(d)(3) did not exist until 1984. Prior to 1984, landlords complained that the Code created a “Neverland” between the filing of a bankruptcy case and a debtor’s decision to assume or reject a lease. During this time of indecision, rents and other obligations under leases were sometimes not performed. The resulting debts were sometimes allowed in full as administrative expenses, sometimes reduced to reflect differing notions of “necessity,” “reasonableness” and “benefit” under § 503(b) and sometimes became (in whole or part) ordinary prepetition claims.

In 1984, Congress changed the relationship between debtors and their nonresidential landlords. Senator Orrin Hatch’s oft-quoted explanation of § 365(d)(3) provides ammunition for all sides of the § 365(d)(3) debate:

A second and related problem is that during the time the debtor has vacated space but has not yet decided whether to assume or reject the lease, the trustee has stopped making payments due under the lease. These payments include rent due the landlord and common area charges which are paid by all the tenants according to the amount of space they lease. In this situation, the landlord is forced to provide current services — the use of its property, utilities, security, and other services— without current payment. No other creditor is put in this position. In addition, the other tenants often must increase their common area charge payments to compensate for the trustee’s failure to make the required payments for the debtor.

This bill would lessen these problems by requiring the trustee to perform all the obligations of the debtor under a lease of nonresidential real property at the time required in the lease. This timely performance requirement will insure that debtor-tenants pay their rent, common area, and other charges on time pending the trustee’s assumption or rejection of the lease.

130 Cong. Rec. S8887, S8894-95 (daily ed. June 29, 1984) (remarks of Senator Hatch).

The Sixth Circuit has not taken sides in the § 365(d)(3) debate. But in a bankruptcy context with many important similarities, the Sixth Circuit suggested the outcome reached by the bankruptcy court in this case. In Vause v. Capital Poly Bag, Inc. (In re Vause), 886 F.2d 794 (6th Cir.1989), the debtors filed Chapter 11 four days before a lease required a $36,000 annual rental payment for the use of farm land. Concurrently with the petition, the debtors rejected the lease. The lease in Vause, though typical for farm leases, was unusual in that rent for each year was payable once annually in arrears.

The landlord filed a proof of claim that included $36,000 for the 361 days of use of the land through the date of the petition. The debtors objected arguing under § 502(b)(6)(B)² that there was no “unpaid rent due under such lease” on the petition date because the lease did not require payment until four days after the petition was filed.

The Sixth Circuit found the word “due” in § 502(b)(6)(B) to be ambiguous in the context of a lease that made rent payable in arrears: In this peculiar context, “due” could mean “ ‘the mere state of indebtment ... or ... the fact that the debt has become payable.’ ” Id. at 799 (quoting United States v. State Bank of N.C., 31 U.S. (6 Pet.) 29, 36, 8 L.Ed. 308 (1832)). The court consulted legislative history, other canons of statutory construction and equitable considerations, ultimately concluding that the landlord was entitled to 361 days of “accrued” prepetition rent.

But the Sixth Circuit was careful in Vause to state that the ambiguity it found in § 502(b)(6) would not arise if the lease required payments in advance. As stated by the court, “Section 502(b)(6) is not difficult to apply when a lease does not make rent payable in arrears. It limits a lessor’s claim to actual past damages for unpaid rent due under the lease.... The problem arises when lease payments are payable in arrears.” Id. at 798-99 (footnote omitted).

The analytical framework in Vause is useful here and supports the bankruptcy court’s conclusion. The meaning of “obligations ... arising ... under any unexpired lease” in § 365(d)(3) is not ambiguous in the narrow context of a lease that required payment of one month’s rent in advance the day before rejection.

As the Sixth Circuit counsels in Vause, this interpretation of § 365(d)(3) must be confined to these facts. Left for another day is the question whether ambiguities of interpretation arise under § 365(d)(3) when a nonresidential lease requires substantial payments in arrears or imposes obligations that are fundamentally inconsistent with other provisions of the Bankruptcy Code.

Y. CONCLUSION

The decision of the bankruptcy court is AFFIRMED.

1 . Appellant argues a second issue for the first time on appeal: that the lease itself limits the landlord’s recovery to two days’ rent. Paragraph 5(b) of the lease provides:

(b) If the Lease term shall commence on a day other than the first day of a calendar month or shall end on a day other than the last day of a calendar month, tire minimum rental for such first or last fractional month shall be such proportion of the monthly minimum rental as the number of days in such fractional month bears to the total number of days in such calendar month.

Appellate courts ordinarily do not consider issues raised for the first time on appeal. See Zirnhelt v. Madaj (In re Madaj), 149 F.3d 467, 471 n. 4 (6th Cir.1998); Harshbarger v. Pees (In re Harshbarger), 66 F.3d 775, 777 n. 3 (6th Cir.1995). An argument is waived that is not first presented to the bankruptcy court. See Daniel v. AMCI, Inc. (In re Ferncrest Court Partners, Ltd.), 66 F.3d 778, 782 (6th Cir.1995).

The Sixth Circuit recognizes exceptions to this general rule. Appellate courts have discretion to consider issues not raised in the trial court in "exceptional cases” or when "a plain miscarriage of justice” would otherwise result. United States v. Reed, 141 F.3d 644, 651-52 (6th Cir.1998); see also Norpak v. Eagle-Picher Indus., Inc. (In re Eagle-Picher Indus., Inc.), 131 F.3d 1185 (6th Cir. 1997) (remanding appeal to prevent a miscarriage of justice); Friendly Farms v. Reliance Ins. Co., 79 F.3d 541, 545 (6th Cir.1996); Kuper v. Iovenko, 66 F.3d 1447, 1454 (6th Cir.1995) (new issue may be considered on appeal where it " 'is presented with sufficient clarity and completeness and its resolution will materially advance the progress of already protracted litigation’ ”).

The parties have not briefed paragraph 5(b) of the lease and certainly have not presented the paragraph 5(b) issue “with sufficient clarity and completeness” for the Panel to determine the effect of this provision. Nothing before the Panel suggests the presence of a "miscarriage of justice” nor has any new development interceded after the filing of this appeal. Accordingly, this is not the "exceptional case” in which it would be appropriate to consider the issue first raised on appeal.

2 . Section 502(b)(6)(B) concerns the allowance of claims and provides:

(b) Except as provided ..., if [a party’s] 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—

(B) any unpaid rent due under such lease, without acceleration, on the earlier of such dates [.]

11 U.S.C. § 502(b)(6)(B).