In Re Bygaph, Inc.
CORRECTED OPINION
The debtor-in-possession, Bygaph, Inc. (“Bygaph”), seeks an order of this court permitting it to assume and assign a lease and to sell the furniture, fixtures, and equipment located on the premises pursuant to §§ 363(f) and 365 of the Bankruptcy Code, 11 U.S.C. §§ 363(f), 365 (1984) (the “Code”). The motion is opposed by 2160 Broadway Corp. (the “Landlord”), by Border Cafe West Corp. (“Border West”), which entered into a subsequent lease for the same premises and was permitted to intervene in opposition, and by Citibank N.A., holder of a security interest in the equipment and fixtures. By order of November 21, 1985, this Court granted the motion. This opinion sets forth the reasons for that decision.
I
R.M.R. Restaurant Corporation (“RMR”) leased certain restaurant premises located at 76th Street and Broadway in Manhattan from the Landlord prior to October 14, 1981. On that date, RMR entered into an agreement with Bygaph whereby it contracted to sell the restaurant to Bygaph and Bygaph agreed to pay cash and certain rent arrearages, and also to make payments on loans made to RMR including obligations to Citibank N.A. and National Westminster Bank USA. At the same time, the RMR lease was terminated and Bygaph entered into a fifteen year lease for the premises directly with the Landlord (the “Lease”).
A modification to the agreement was agreed to on March 19, 1982, changing the purchase price and affording RMR with security for Bygaph’s obligations to it. Pursuant to that modification, Bygaph, on April 8, 1982, granted RMR a security interest in the chattels and fixtures on the restaurant premises, assigned the Lease to RMR, and received a sublease providing that Bygaph agreed to pay, as part of its rent obligations, the sums owed the banks. Concurrently, RMR reassigned the paramount Lease to the debtor. The reassignment was to be held in escrow pending Bygaph’s satisfaction of its contracted obli
In June, 1984, both Citibank and National Westminster Bank apparently informed RMR that certain payments on the respective loans had not been made. The Landlord contends that, pursuant to the sublease, RMR notified Bygaph by letter of June 26, 1984 of the defaults, and that unless the defaults were cured within five days of the receipt of the letter, the sublease would expire on July 6, 1984. By-gaph disputes receiving the letter.
RMR, on July 11,1984, brought an action in the Supreme Court of the State of New York, County of Delaware, seeking a declaration that the sublease be declared null and void and terminated as of July 6, 1984. The state court entered an order granting RMR’s motion for summary judgment on September 26, 1984, holding Bygaph in default because its answering papers were delivered to the courthouse one hour after the motion was submitted. Bygaph immediately moved to vacate the default. In a decision dated November 23, 1984, and by order entered December 12, 1984, the court granted the debtor’s motion to vacate the default judgment only to the extent that money damages had been awarded. It refused to vacate that portion of the motion which rendered the sublease null and void and entitled RMR to take possession of the premises. Bygaph appealed.
The restaurant was closed in August, 1984, leaving no indication of Bygaph’s or RMR’s interest in the premises. Bygaph filed a Chapter 11 petition on November 4, 1984. On February 10, 1984, it sought this Court’s approval to assume and assign its lease pursuant to § 365 of the Bankruptcy Code, and to sell substantially all its other assets, pursuant to § 363(f) of the Code, to Broadway Beach Corp. RMR, implicitly relying on § 365(c)(3) of the Code, objected to the motion on the ground that this lease of nonresidential real property could not be assumed because it had terminated under applicable non-bankruptcy law prior to the order for relief, and that the state court’s order of September 26, 1984 had provided RMR with possession of the premises.
The debtor, in response, asserted that its relationship with RMR was not truly a landlord-tenant relationship, but was rather more in the nature of a security agreement, and that consequently a termination of the sublease agreement did not terminate the leasehold. Secondly, it argued that even if its leasehold was deemed terminated, this Court should revive it based on equitable considerations.
The landlord also objected to the motion on the ground that the proposed assignee, a corporation owned by one Albert H. Soco-lov, had not furnished adequate assurance of future performance as required by § 365(f)(2)(B) of the Code. At a hearing held on March 18, 1985, Mr. Socolov testified as to his ability to provide such assurance.
The testimony revealed that Socolov, who is a practicing attorney, is also a successful restaurateur. He owns and profitably operates a Mexican restaurant in lower Manhattan called The Beach House. Among the financial assets available to Mr. Socolov are $237,000 in an insured market rate account, and securities worth $423,000 at the time of the hearing. In addition, he stated that The Beach House grosses approximately $60,000 per month during the spring and the fall, which are its peak business periods. He testified that he had not been as much as a month late on his rent obligations in connection with The Beach House.
To this, Socolov added that he had budgeted approximately $275,000, entirely from his personal assets, to capitalize Broadway Beach Corporation and thereby enable it to purchase the restaurant from the debtor and open a new Mexican-style restaurant on the premises. $166,000 was to be used for the purchase of the establishment, leaving an excess of $110,000. $75,000 of this amount would be used to restore the premises, and the remainder would serve as a reserve fund. Socolov projected that he would lose approximately $10,000 per month initially on the restau
In an unpublished opinion dated April 22, 1985, a motion to assume the Lease was denied on the basis of the state court decision then outstanding, which provided that the debtor’s interest in the sublease had terminated and that RMR was entitled to possession. This Court, absent reversal or appeal of that decision, was unable to revisit it to determine on the merits whether the debtor’s sublease was rightly terminated. In the Matter of Bygaph Corporation, No. 84 B 11550, slip op. (Bankr.S.D.N.Y. April 22, 1985). For this reason we did not rule on the issue of whether adequate assurance of future performance had been furnished or whether Bygaph, as debtor-in-possession, could void the assignment.
Shortly thereafter, RMR purported to surrender the Lease to the Landlord without apparent consideration by turning over the keys at the end of April, 1985, and delivering a document, dated May 9, 1985, which provided:
R.M.R. RESTAURANT, INC. for good and valuable consideration hereby surrenders to 2160 BROADWAY CORP. any and all interest in lease to premises situated at 2160 Broadway, New York City held by reason of interest in lease dated October 14, 1981.
The Landlord thereupon, on September 11, 1985, entered into a lease of the restaurant premises with Border West, which included a provision for the lessee to pay additional rent of $50,000 in cash in ten days and $50,000 in promissory notes (the “Border West Lease”). This sum was calculated to make up the arrears owed by Bygaph to the Landlord. Charles Leaness, president and director of Border West, testified that he was referred to the landlord by a Dr. Michael Wiland, a principal of RMR, who set up a meeting between Leaness and the landlord. Leaness stated that his inspection of the premises before entering into the Border West Lease did not indicate any interest of Bygaph or RMR in the leasehold. He added that he knew Wiland had an interest in the equipment and fixtures and that Border West had assumed RMR’s obligation to the two banks in order to obtain them.
The Border West Lease, however, revealed that Wiland also had an interest in the subject property. Clause 67 provides that:
It is understood and agreed that the interest of Dr. Michael Wiland and his associates must be resolved to his satisfaction and his approval to this lease shall be required.
The Border West Lease itself makes clear that this interest is an interest in the leasehold, and not just the fixtures as Leaness claimed. Paragraph 62 of the lease provides that the Landlord does not own the fixtures, and paragraph 68 conditions the lease upon Border West’s obtaining title to them. Border West nevertheless asserts that it did not know of the state court litigation between RMR and Bygaph, the litigation in this Court, or any other facts. It does not claim to have made any inquiry of either the nature of Wiland’s interest, by whom the arrears were owed, or why the prior restaurant had failed.
On September 26, 1985, the New York State Supreme Court, Appellate Division, Third Judicial Department vacated the default judgment against the debtor in its entirety, reversing the lower court’s determination that RMR had rightful possession of the property. Bygaph thereupon brought the instant motion seeking to assume and assign the Lease to Socolov’s corporation. Bygaph would satisfy the Citibank and National Westminster secured claims by paying $12,970.00, the value of
II
Citibank objects to the debtor’s motion on the ground the Lease is to be deemed rejected by virtue of section 365(d)(4) of the Code. 2 This section, added to the Code pursuant to the Bankruptcy Amendments and Federal Judgeship Act of 1984, P.L. 98-353, 98 Stat. 333 (1984), sets forth a sixty day time period from the order of relief, subject to extension granted within that period for cause by the court, in which a debtor-in-possession must assume or reject an unexpired lease of nonresidential real property. A lease that is not assumed within these time parameters is deemed rejected.
We hold that the debtor’s application to assume and assign, under these circumstances, does not run afoul of § 365(d)(4). The Appellate Division’s September 26, 1985 decision to vacate the default judgment against the debtor effectively reinstated whatever ability Bygaph had to assume and assign the Lease. The debtor’s current motion was made well within sixty days of that decision.
As the Landlord notes, it is plainly apparent that Congress hardly envisioned this set of circumstances in enacting § 365(d)(4). The legislative history indicates that Congress sought to relieve landlords of some of the uncertainty and delay inherent in lease assumption decisions, and to decrease the attendant problems of extended vacancies and partial operation of tenant space by bankrupt tenants.
In re By-Rite Distributing, Inc.,
In the same breath, Congress evinced a concern for federalism and recognized the dual system of federal and state courts by precluding assumption if a
... lease of nonresidential real property has been terminated under applicable non-bankruptcy law prior to the order for relief.
§ 365(c)(3). Permitting the sixty day period of § 365(d)(4) to preclude assumption under these circumstances would deprive the state court system of the power to correct its own errors or force it to act with undue haste. Understandably, there is not the slightest indication that Congress intended such a result. 3
Ill
In addressing the merits of the motion, the Landlord asserts that the sublease was terminated on July 6, 1984, pursuant to Bygaph’s failure to perform an alleged conditional limitation of payment of RMR’s obligations to Citibank and National Westminster Bank, and that RMR therefore had full rights to the Lease pursuant to the assignment it received. Bygaph denies that state law requirements of notice of termination were fulfilled, and asserts that the documents taken together are nothing more than a security device entitling RMR only to the rights of a secured creditor. It further asserts that it, as debtor-in-possession, has the rights of a bona fide purchaser under § 544(a)(3) of the Code and that notwithstanding the purported termination of the sublease, the assignment is thereby voidable.
Section 544(a) of the Code, in pertinent part, provides:
(a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by—
(3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.
11 U.S.C. § 544(a)(3).
A debtor-in-possession can avoid an assignment of an interest in real property under this section if a hypothetical bona fide purchaser on the date the bankruptcy case was commenced could do so.
McCannon v. Marston,
constructive notice of what may be revealed by: (i) an examination of the record, e.g., Andy Associates v. Bankers Trust Co.,49 N.Y.2d 13 ,424 N.Y.S.2d 139 ,399 N.E.2d 1160 (1979), (ii) reasonable inquiry of those in actual possession, see Wardell v. Older,70 A.D.2d 1008 ,418 N.Y.S.2d 196 (1979), or (iii) reasonable inquiry on the basis of all the circumstances. See In re Hardway, 31B.R. 322, 10 B.C.D. 1063 , 1068 (Bkrtcy.S. D.N.Y.1983).
In re Euro-Swiss International Cory, at 882. As the statute provides, the debtor-in-possession’s actual knowledge is ruled out. 4 But a trustee or debtor-in-possession is subject to constructive notice as opposed to knowledge. “The choice of that term rather than the broader term ‘notice’ ... indicates that Congress did not intend to shield the trustee under § 544(a)(3) from the effect of constructive notice.” Id. at 881.
Here, an assignee of the Lease on the date the bankruptcy petition was filed would have learned nothing from examination of the record because none of the documents were recorded. Nor would notice of the assignment by Bygaph to RMR have been revealed from examination of the premises or inquiry of those who were found there, for the restaurant was boarded up and there was no indication on the property that any third party was in possession or might have had an interest in it.
Compare, Euro-Swiss,
IV
As to Bygaph’s ability as debtor-in-possession to satisfy those standards, Border West and the Landlord assert that assumption and assignment are precluded by the Landlord subsequently having entered into a lease with Border West, and because, in their view, the requisite adequate assurance of future performance required by § 365(b) and § 365(f) has not been met.
Nowhere in § 365 is it expressly provided that the ability to assume and assign a lease is constricted by the landlord’s having let the premises to another tenant. Section § 365(c)(3)’s limitation of
Border West’s claim to be such a bona fide purchaser is, however, unavailing. The evidence on this record overwhelmingly shows that they had more than sufficient constructive notice of Bygaph’s interest in the property. Having learned from a principal of RMR about the availability of the premises, it had reasonable cause to inquire about RMR’s interest and thereby could have learned of RMR’s arrangement with Bygaph. Indeed, Border West’s lease with the Landlord was conditioned on satisfying the interest of Wiland and his associates at RMR. In the course of determining what would be required to discharge that condition, Border West would surely have learned of the pendency of Bygaph’s appeal.
Not to the contrary is RMR’s having previously executed a surrender of lease in May, 1984. The Border West Lease was prepared some three or four months later and the presence of the condition is more than a sufficient indication of the Landlord’s, and apparently RMR’s, concern as to the efficacy of that document.
Nor does Leaness’ implication that he thought RMR’s interest was limited to the fixtures withstand even the most cursory examination. The Border West Lease is expressly conditioned on obtaining title to the fixtures and satisfying Wiland and his associates. Even were Leaness’ testimony to be accepted, moreover, it would seem .that under the circumstances a reasonably prudent prospective tenant had cause at least to inquire as to whether the owner of the fixtures had any extant interest in the premises themselves.
These circumstances include the condition to the Border West Lease, contained in the same clause as the fixture and equipment obligation, that requires Border West to make $100,000 in additional payments. The testimony of the Landlord revealed that these payments were for rent arrear-ages owed by Bygaph to 2160 Broadway Corporation. Although they are not labeled as such, the organization of the Border West Lease indicates that the sums enumerated do not represent rent, which is clearly and fully provided for by a separate rent rider, but merely supplemental payments due to the Landlord, styled “additional rental,” the payment of which is in some manner related to the tenant paying for the fixtures. While this clause does not expressly state that Border West must pay rent arrearages, its wording, when read in the context of the surrounding clauses and the lease as a whole, constitutes a circumstance which should have prompted an inquiry concerning the reasons for the requirement and who owed the rent arrearag-es, and thus should have induced further inquiry by the prospective lessee as to whether there were prior unrecorded interests in the property.
6
With the eircum-
Accordingly, we turn to the requirements for the assumption and assignment of an unexpired lease provided by § 365 of the Code. Section 365(b) sets forth the requirements a debtor must satisfy in order to assume an unexpired lease in which there has been a default. Section 365(f)(2)(A) provides that the debtor may assign the lease only if it first assumes it in accordance with the requirements of the applicable provision of § 365, which in this case would be § 365(b)(1), and adequate assurance of future performance by the assignee is provided pursuant to § 365(f)(2)(B).
The debtor’s proposal, as stated in its motion, cures all rental defaults on the Lease by paying $124,500.00 to the Landlord, plus rent until closing, in cash upon assumption and assignment. Proceeds sufficient to pay other alleged defaults are to be received and held.
See
n. 1
supra.
The only issue presented concerns adequate assurance of future performance under the Lease. Adequate assurance is required by both the assumption and the assignment provisions of § 365. In this case, “... the assurance tendered by the debtor upon the assumption of the lease is the prospective performance of the assignee...”
In re Evelyn Byrnes, Inc.,
Congress intended that the words “adequate assurance” be given a practical, pragmatic construction, and is to be determined under the facts of each particular case.
In re Sapolin Paints, Inc.,
The chief determinant of adequate assurance of future performance is whether the rent will be paid.
In re Natco Industries,
at 440-41;
In re Evelyn Byrnes, Inc.,
V
With respect to that portion of the motion seeking to sell the fixtures and equipment free and clear of the banks’ liens,
7
§ 363(f)(3) provides that the debtor-in-possession may sell the secured creditor’s interest in the collateral property free and clear if “such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property.”
8
The secured creditor has the burden of proof under § 363(o)(2) to establish the extent of its interest,
i.e.
the value of the collateral. Its right to adequate protection is limited to the lesser of the value of the collateral or the amount of the secured claim.
In re Aegean Fare Inc.,
Here, Citibank and National Westminster Bank have asserted liens of approximately $87,000.00, claiming to be secured lenders in that amount. The value of the collateral, however, is sharply disputed. To discharge its burden of proof, Citibank has submitted an appraisal that states that the collateral has a liquidation value of $12,970 and a “greater value in its [sic] present location as they are in place and connected to gas, electric and water services,” and that Socolov, in August 1984, in connection with his prior offer, agreed to pay $30,428.70 for same. It also observes that Border West has agreed to pay some $87,000 for the collateral. This last assertion, however, is of little weight since it was made under the compulsion of that provision of the Border West Lease requirement of satisfaction of the owner of the fixtures who owed that sum to Citibank. There is no evidence that Border West would pay that sum separately for the collateral or were the debtor authorized to assume and assign the Lease as we have held.
As to the other values profferred, the difference of roughly $17,500 can be partly, if not wholly, attributed to the cost of removal and installation of replacement fixtures and equipment, as the Citibank appraisal suggests. A value of $30,428.70, moreover, is supported not only by Soco-lov’s apparent valuation in August 1984 but also by the notion that disposal in accordance with the transfer of the premises, unburdened by coercion such as contained in the Border West Lease, would appear to be within the reasonable contemplation of a holder of a lien secured by this type of collateral. Citibank has offered neither testimony of such a contemplation, nor any evidence of being able to compel the Landlord to lease the premises only upon the condition that a prospective tenant obtain the fixtures for the full amount of the banks’ debt. There is testimony by Leaness that the premises were in considerable
Such a value, when added to the amount of $124,500.00 necessary to cure the rental default through October, and an additional rent of $6,000 for November, equals $160,-928.70, which is within the aggregate cash consideration of $150,000 plus a discounted value of $101,867.10 for the notes, even were the debtor obligated to repair the boiler and pipes. 9 The conditions of § 363(f)(3) thus being satisfied, the collateral may be sold with the lien attaching to the proceeds pending further order of this Court. Under the legislative history, adequate protection would apparently be thereby furnished to the banks for the value of their lien. See H.R. No. 95-595, 95th Cong., 1st Sess. 345 (1977), U.S.Code Cong. & Admin.News 1978, pp. 5787, 6301.
But § 363(e) of the Bankruptcy Code provides that the court shall condition the sale of property by the trustee to provide adequate protection for an interest which an entity holds in the property. Adequate protection, as defined by § 361(3) to include indubitable equivalence, is broader than the attachment of a lien to the proceeds of a note. Although the legislative history noted above refers to proceeds rather than cash, on reconsideration it appears that adequate protection here could only contemplate continuance of the lien to assure the receipt of the value found.
The foregoing constitutes findings of fact and conclusions of law pursuant to Rule 7052 of the Rules of Bankruptcy Procedure.
Notes
. The Landlord claims that the boiler is in disrepair, pipes are broken and that Bygaph has the obligation to repair them. Bygaph disputes the allegation. The parties agree that if the obligation exists, it is curable. A further hearing in this regard is necessary. Proceeds in addition to the amount necessary to pay back rent are to be held pending further order of the Court.
. Section 365(d)(4) provides:
Notwithstanding paragraphs (1) and (2), in a case under any chapter of this title, if the trustee does not assume or reject an unexpired lease of nonresidential real property under which the debtor is the lessee within 60 days after the date of the order for relief, or within such additional time as the court, for cause, within such 60-day period, fixes, then such lease is deemed rejected, and the trustee shall immediately surrender such nonresidential real property to the lessor.
11 U.S.C. § 365(d)(4) (1984).
.In
In re By-Rite Distributing, Inc.,
. Section 544(a) states that the grant of the avoidance power to the trustee is not conditioned on any knowledge of the trustee or of any creditor. This "without knowledge” provision refers to actual notice to the trustee.
In re Euro-Swiss International Corporation,
. In light of the application of the debtor-in-possession's power under § 544(a)(3) to avoid the assignment of the lease to RMR, we need not reach the issue of whether the assignment was a security device, nor rule on the Landlord’s contention that the Lease was irrevocably terminated as a result of the debtor’s default on his obligation to make payments to Citibank pursuant to the terms of the sublease between RMR and Bygaph, and its failure to cure the default.
See First National Stores v. Yellowstone Shopping Center,
Such a resolution would involve not only the factual issue of whether notice of termination had been given, but also the legal issue of whether § 365(c)(3), precluding assumption if a lease has been terminated under state law, applies in view of the purported termination of the sublease pursuant to a conditional limitation which is not favored, and in view of the curative provisions of §§ 365(b)(1)(A) and 1124(2)(A) of the Code.
See, In re Taddeo,
. These interests are distinct from the former interest of RMR referred to in the Lease of October 14, 1981 which was subject to RMR’s surrender of its earlier lease of July 7, 1978. Unlike the situation with Bygaph’s interest, the record contains no suggestion that the condition was not fulfilled and a bona fide purchaser would have little if any reason to inquire since there was nothing that would indicate that By-gaph was not in possession or that there existed a subsequent unrecorded assignment. The clauses of the Border West Lease gave notice of
. Citibank also asserts a lien on the lease. It, however, has offered no evidence that the lien was recorded and the debtor claims that it was not.
. Citibank claims that the debtor must satisfy the other provisions of § 363(f). The use of the word "or,” however, makes each of the provisions of that section disjunctive.
. The notes are payable over five years, according to the terms of the notice of sale dated October 3, 1985. (Although Socolov’s October 2, 1985 affidavit states that the notes are payable over six years, the terms of the notice of sale are binding since that notice was sent to creditors.) There is no evidence that the notes will not be paid and Citibank fails to so contend. Assuming equal monthly payments of $2,500 over five years at a discount rate of 13‘/2%, which equals the prime rate of 9‘/2% as of November 21, 1985, LXV Barrons, No. 47, p. 131 (November 25, 1985), plus 4%, the notes have a discounted value of $108,649.14. At a discount rate of 16.42%, which is the national average unsecured loan rate for 24 month obligations for this week, USA TODAY, November 22, 1985, p. IB, the notes have a value of $101,867.10.