Bagel v. Chicken Debtor v. Debtor Can Anyone Get a Home Field Advantage

Bagel v. Chicken Debtor v. Debtor Can Anyone Get a Home Field Advantage

Journal Issue: 
Column Name: 
Journal Article: 
The last time that the World Series featured two teams that played their home games in the same ballpark was during World War II. By the 1944 season, most of baseball's stars had traded their flannels for fatigues, and all teams were badly depleted. In the World Series in October of that year, the St. Louis Cardinals (who had managed to hold onto their greatest of stars, Stan Musial, during the war) defeated the St. Louis Browns (winners that year of the Browns's only American League pennant in 52 seasons before becoming the Baltimore Orioles). Both teams played their home games in Sportsman's Park in St. Louis, so neither team could boast a home-field advantage during the World Series. The Browns were perennial also-rans, and it took a world war to thin sufficiently the rosters of the Yankees and the Tigers to allow the lowly Browns to eke out their only-ever World Series berth. Inevitably, such extraordinary circumstances can carry a substandard team only so far. Musial batted .304, the Browns scored only 12 runs in six games, and the Cardinals won the Series in front of their, and their opponent's, home crowd four games to two.1

Fifty-six Octobers later, two other opponents met in another common "home field." This time, the extraordinary circumstances were economic, and a bankrupt bagel company and a bankrupt chicken company sought to resolve their dispute before the same bankruptcy judge presiding over both companies' chapter 11 cases. Einstein/Noah Bagel Corp., whose chapter 11 case was pending before Judge Charles G. Case Jr. in Phoenix, filed certain administrative expense claims against Boston Chicken Inc., whose chapter 11 case also was pending before Judge Charles G. Case Jr. in Phoenix. When it was over, Boston Chicken had swept Einstein Bagel three straight—in the bankruptcy court,2 Ninth Circuit Bankruptcy Appellate Panel3 and Ninth Circuit Court of Appeals.4

The issue between Einstein Bagel and Boston Chicken—certainly every bit as riveting as the Fall Classic of 1944—was the interpretation of the statutory language of Bankruptcy Code §365(d)(3),5 specifically whether §365(d)(3) applies to a debtor as a lessor as well as a debtor as a tenant. Stated differently, does Bankruptcy Code §365(d) (3) require a debtor-lessor to "timely perform all obligations of the debtor," including non-monetary obligations as lessor, and does a debtor-lessor's failure give rise to an administrative expense claim in favor of the tenant? The bankruptcy court noted that neither the bagel guys nor the chicken guys were able to locate any prior cases addressing this point.6 The Ninth Circuit agreed, calling the issue "one of first-impression in this circuit."7

In 1996, Einstein Bagel and Boston Chicken—which owned half of Einstein Bagel's outstanding shares—entered into several agreements with one another. One of these agreements was a five-year lease, under which Boston Chicken subleased certain office space in its Golden, Colo., headquarters to Einstein Bagel. Boston Chicken leased the entire building from Prudential Insurance Co. In a 1998 amendment to that sublease, Boston Chicken agreed to use its "best efforts" to obtain a non-disturbance agreement from Prudential, which would have protected Einstein Bagel from being ousted by Prudential if Boston Chicken defaulted under its prime lease. Five months later, Boston Chicken filed its chapter 11 petition, never having obtained the non-disturbance agreement from Prudential. Einstein Bagel, devoid of its non-disturbance agreement, feared that Boston Chicken's financial distress, bankruptcy and souring relationship with Prudential would imperil Einstein Bagel's ability to retain its office space. Einstein Bagel decided to relocate its offices in 1999. As anticipated, Boston Chicken sought and obtained an order in its chapter 11 proceeding in 2000 that authorized Boston Chicken to reject its sublease with Einstein Bagel under Bankruptcy Code §365(a).8

Before the May 2000 confirmation of Boston Chicken's plan (which provided primarily for the sale of most of Boston Chicken's assets to a subsidiary of the McDonald's Corp.), Einstein Bagel filed a request for payment of certain administrative expenses. Principal among these expenses was a claim for $1.5 million in relocation costs that Einstein Bagel attributed to Boston Chicken's failure to use its best efforts to obtain the non-disturbance agreement from Prudential. (Einstein Bagel's own chapter 11 case began shortly thereafter.)9 The crux of the claim was that in failing to use its best efforts, Boston Chicken had failed to "timely perform all [its] obligations" in the unexpired sublease under Bankruptcy Code §365(d)(3).

The bankruptcy court granted summary judgment to Boston Chicken (actually, by then, the plan trustee), ruling that Congress did not intend to have §365(d)(3) apply to debtors as lessors.10 The Bankruptcy Appellate Panel (BAP) affirmed on essentially the same grounds.11 The Ninth Circuit also affirmed, citing the same legislative history and tenets of statutory interpretation on which the Bankruptcy Court and the BAP had relied.12

The Ninth Circuit cited the legislative statements of Sen.13 Orrin Hatch (R-Utah) regarding the 1984 amendments that added §365(d)(3) to the Bankruptcy Code: "The landlord is forced to provide current services—the use of its property, utilities, security and other services—without current payment."14 The Ninth Circuit concluded that §365(d)(3) was intended to protect lessors only, also relying, as did the lower courts, on the last sentence of §365(d)(3), which speaks exclusively of the "'lessor's rights' under 'such lease' agreements, referring back to the lease discussed in the first sentence. These statements should be read together to determine the meaning of the statute."15 In doing so, the Ninth Circuit concluded that "taken together, §365(d)(3)'s first and last sentences indicate that the section applies only when a lessor is accepting performance from the debtor lessee."16

As a result, Einstein Bagel was entitled, at best, to a general unsecured claim for Boston Chicken's alleged failure to obtain the non-disturbance agreement from Prudential, which purportedly forced Einstein Bagel to incur $1.5 million in relocation costs. (Einstein Bagel's alternative argument for an administrative expense priority under Bankruptcy Code §503(b)(1)(A) was more easily rejected on a "benefit to the estate" analysis.17)

Although the decisions do not mention this, the stakes of bagel v. chicken were rather high. Left with a general unsecured claim, Einstein Bagel was placed in the unenviable position of all other general unsecured creditors in the Boston Chicken case, who all received a distribution of an amount that resembled, well, a bagel.

It would be fair to characterize bagel v. chicken as a bad result for the creditors of Einstein Bagel. Boston Chicken's creditors had already by then obtained a bad result. It seems that everyone, to a lesser or greater extent, is a loser when one chapter 11 debtor attempts to invoke the Bankruptcy Code's unique powers in a dispute with another chapter 11 debtor. Yet we should expect to see more of this—debtor vs. debtor, Bankruptcy Code section vs. Bankruptcy Code section—as the number of business bankruptcies grows during a faltering economic environment. Novel challenges will continue to face restructuring professionals and their clients as bankruptcy cases clash with one another.

Recently in New York, in what might prove an interesting harbinger of things to come, WorldCom Inc., one enormous multinational telecommunications debtor, filed a motion in the chapter 11 case of Global Crossing Ltd., another enormous multinational telecommunications debtor, seeking relief from the automatic stay so that WorldCom could reject certain of its executory contracts with Global Crossing debtor affiliates.18 Although the motion was withdrawn shortly after, it raised the curious issue of whether relief from one chapter 11 debtor's automatic stay under Code §362 is appropriate—or even required—before another chapter 11 debtor may reject an executory contract with the first debtor under Code §365 in the second debtor's bankruptcy proceeding.

The case law is uniformly clear that relief from the stay is required before a non-debtor party to an executory contract may terminate the contract with the debtor. The case law is also clear that the automatic stay under §362 does not operate as a stay against other courts—just other parties—and one could argue convincingly that a court-approved rejection under §365 is an act by a bankruptcy court moreso than the debtor-in-possession or trustee. So, are a debtor's rights under §365 restricted by another debtor's rights under §362?

Only one reported decision—from the last recession—seems to address this concern. In In re Hawaii Dimensions Inc., the bankruptcy court in Honolulu ruled that relief from the stay in the landlord's bankruptcy case was not a necessary prerequisite for the tenant's rejection of an unexpired real property lease.19 The issue was not central to that holding, however, and one might assume that WorldCom was either not aware of or not persuaded by the Hawaii Dimensions holding, since WorldCom did not even cite that decision, or any other, in its motion in the Global Crossing case.

These types of confounding interplays between debtors and Bankruptcy Code provisions—often, as in WorldCom and Global Crossing, in the same court—will likely become more pervasive during economic troughs such as the one that bankruptcy professionals are now perversely enjoying. As more and more companies seek relief under the Bankruptcy Code, their business relationships with other companies who have sought the same relief will more frequently implicate countervailing policies and provisions inherent in the Bankruptcy Code. Can courts resolve these disputes without giving primacy to certain sections of the Bankruptcy Code over others? Is there a "rock/paper/scissors"-type of approach on the horizon?

Try this one: if Company A returns a preferential payment to Company B, a debtor, and Company A itself becomes a debtor within 90 days, can Company A recover the returned preference from Company B as a preference? If so, does Company B have simply a general unsecured resulting claim (cents on the dollar) in exchange for what was once a dollar-for-dollar preference claim? Does your head hurt yet?


1 This had happened only twice before. The New York Yankees and the New York Giants met in the World Series three years in a row in 1921, 1922 and 1923. Because Yankee Stadium did not open until 1923, all Series games in 1921 and 1922 were played in the Polo Grounds, then both teams' home field. Despite having Babe Ruth, the Yankees lost both Series—their two first Series in franchise history. The Yankees exacted their revenge the following year, when the Yankees beat the Giants in the 1923 World Series, half the games of which were played in the new Yankee Stadium—the "House that Ruth Built." Return to article

2 In re BCE West L.P., 257 B.R. 304 (Bankr. D. Ariz. 2000). Return to article

3 In re BCE West L.P., 264 B.R. 578 (9th Cir. BAP 2001). Return to article

4 Einstein/Noah Bagel Corp. v. Smith (In re BCE West L.P.), ___F.3d___, 2003 U.S. App. LEXIS 2718 (9th Cir. Feb. 14, 2003). Return to article

5 Section 365(d)(3) provides in pertinent part:

The trustee shall timely perform all the obligations of the debtor, except those specified in §365(b)(2), arising from and after the order from relief under any unexpired lease or nonresidential real property, until such lease is assumed or rejected, notwithstanding §503(b)(1) of this title... Acceptance of any such performance does not constitute waiver of relinquishment of the lessor's rights under such lease or under the title. Return to article

6 257 B.R. at 308-09 ("Neither party has found a case directly on point... The court has likewise found the case law on this limited point to be non-existent."). Return to article

7 2003 U.S. App. LEXIS 2718 at *6. It does not appear from published decisions that any other circuit has considered the issue to date. Return to article

8 See 264 B.R. at 579-80. Return to article

9 Id. at 580. Return to article

10 257 B.R. at 309. Return to article

11 264 B.R. at 583. Return to article

12 2003 U.S. App. LEXIS 2718 at *8-*9. Return to article

13 Sen. Hatch's music web site is Return to article

14 130 Conf. Rec. S 8891, 8895 (daily ed. June 29, 1984), reprinted in 1984 U.S.C.C.A.N. 576, 598. Return to article

15 2003 U.S. App. LEXIS 2718 at *8 (emphasis in original), citing United Sav. Ass'n of Texas v. Timbers of Inwood Forest Assocs. Ltd., 484 U.S. 365, 371 (1988) (statutory construction of the Bankruptcy Code is "a holistic endeavor"). Return to article

16 2003 U.S. App. LEXIS 2718 at *9. Return to article

17 Id. at *11-*17. Return to article

18 See "Motion of WorldCom Inc. for Relief from the Automatic Stay for Cause to Exercise Right to Reject Executory Contracts with Debtors in the WorldCom Bankruptcy Case," filed Dec. 31, 2002, in In re Global Crossing Ltd. et al., Case No. 02-40188 (jointly administered) (Bankr. S.D.N.Y.). Return to article

19 39 B.R. 606 (Bankr. D. Hawaii 1984). Return to article

Journal Date: 
Tuesday, April 1, 2003