Klairmont Korners, L.L.C. ( 2022 )

Case: 22-40371 Document: 00516500074 Page: 1 Date Filed: 10/06/2022
United States Court of Appeals
for the Fifth Circuit United States Court of Appeals
Fifth Circuit
FILED
October 6, 2022
No. 22-40371 Lyle W. Cayce
Clerk
In the Matter of J. C. Penney Direct Marketing
Services, L.L.C.
Debtor,
Klairmont Korners, L.L.C.,
Appellant.
Appeal from the United States District Court
for the Southern District of Texas
USDC No. 2:21-cv-139
Before Higginbotham, Graves, and Ho, Circuit Judges.
Per Curiam:
Klairmont Korners, L.L.C. (“Klairmont”) appeals a district court
order denying its claim that a debtor’s decision to reject a commercial lease
pursuant to 11 U.S.C. § 365 should not receive deference under the business
judgment rule because of “bad faith, whim, or caprice” inherent in a third
party’s negotiations with Klairmont. Because Klairmont’s contentions fail
under this court’s own standard for overcoming the business judgment rule,
as well as the “bad faith” test Klairmont encourages us to adopt, we affirm.
Case: 22-40371 Document: 00516500074 Page: 2 Date Filed: 10/06/2022
No. 22-40371
I.
Klairmont obtained a sublease from J.C. Penney Properties, Inc.
(“JCP”) for commercial real estate, where the latter acted as a pass-through
entity between Klairmont and the landowner. In 2020, JCP filed for relief
under Chapter 11 of the Bankruptcy Code, allowing it to assume or reject
ongoing commercial leases pursuant to 11 U.S.C. § 365. Given that the lease
and sublease locked in below-market rates, Klairmont stood to gain from
assumption, while the landowner would benefit from rejection. A real estate
agent hired to negotiate with the parties provided Klairmont with false
information to start a bidding war among interested parties and hindered the
company’s ability to participate fully in the process, although JCP did
eventually receive Klairmont’s increased bids. Following negotiations, and
at the direction of the company purchasing its assets, JCP chose to reject its
sublease to Klairmont, a decision generally afforded deference under the
business judgment rule.
The bankruptcy court acknowledged that the process was “not one
that we can be proud of” but asserted that the decision to reject the lease
rested on JCP’s own business judgment regarding the financial benefits of
each option. Klairmont appealed the bankruptcy court’s order to the district
court, which affirmed. Klairmont then appealed to this court on two issues:
(1) whether “bad faith, whim, or caprice” inherent in a third party’s
negotiation of contract rejection under § 365 overcomes the business
judgment rule, and (2) whether JCP’s action at the direction of the company
purchasing its assets insulated it from this “bad faith” standard. Because
Klairmont’s formulation of its proposed standard lacks merit, we do not
address the second issue.
2
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II.
In bankruptcy cases, this court employs the same standard of review
as a district court sitting in an appellate capacity. 1 The district court reviews
a bankruptcy court’s findings of fact under a clearly erroneous standard and
conclusions of law de novo, so we will do likewise. 2 We review de novo, and we
have jurisdiction under 28 U.S.C. § 158(d).
The federal Bankruptcy Code states that a “trustee [or debtor],
subject to the court’s approval, may assume or reject any executory
contract.”3 Executory contracts include those agreements under which
“each side has at least one material unperformed obligation as of the
bankruptcy petition date,”4 a category that includes the sublease at issue in
this dispute. A bankruptcy court reviews a debtor’s decision to assume or
reject an executory contract under the deferential “business judgment”
standard.5 We have held that “as long as assumption of a lease appears to
enhance a debtor’s estate,” a bankruptcy court should only withhold
approval when “the debtor’s judgment is clearly erroneous, too speculative,
or contrary to the provisions of the Bankruptcy Code.”6 Furthermore, “it is
1
In re SI Restructuring, Inc., 542 F.3d 131, 134 (5th Cir. 2008); Richmond Leasing
Co. v. Cap. Bank, N.A., 762 F.2d 1303, 1309 (5th Cir. 1985).
2
Matter of Berryman Prods., Inc., 159 F.3d 941, 943 (5th Cir. 1998).
3
11 U.S.C. § 365.
4
Matter of Falcon V, L.L.C., 44 F.4th 348, 352 (5th Cir. 2022) (citing In re Weinstein
Co. Holdings L.L.C., 997 F.3d 497, 504 (3d Cir. 2021)).
5
Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 (2019);
Richmond Leasing Co. v. Cap. Bank, N.A., 762 F.2d 1303, 1308–09 (5th Cir. 1985).
6
Richmond Leasing Co., 762 F.2d at 1309.
3
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the debtor who decides whether to maintain the contract,” rather than any
third party.7
In applying the business judgment standard, Klairmont encourages
this court to additionally ask whether JCP’s decision “is the product of bad
faith, or whim, or caprice.”8 We do not adopt that test today, but we
nonetheless demonstrate that Klairmont’s claim fails under both standards.
III.
Klairmont misapprehends the lens through which courts view the
business judgment rule. The question is not whether the debtor’s decision
reasonably protects the interests of other parties, but rather whether the
decision “appears to enhance a debtor’s estate.”9 This distinction proves
fatal to Klairmont’s claim, as bankruptcy, by definition, often adversely
affects the interests of other parties. The long-standing purpose of allowing
debtors to shed executory contracts is to afford trustees and assignees the
opportunity to reject “property of an onerous or unprofitable character.” 10
The correct inquiry under the business judgment standard is whether the
debtor’s decision regarding executory contracts benefits the debtor, not
whether the decision harms third parties.
Klairmont does not contend that JCP’s decision to reject the lease
failed to enhance its estate. Neither does Klairmont assert that JCP’s action
on behalf of its estate was clearly erroneous, too speculative, or contrary to
7
In re Nat’l Gypsum Co., 208 F.3d 498, 505 (5th Cir. 2000).
8
In re Wheeling-Pittsburgh Steel Corp., 72 B.R. 845, 849 (Bankr. W.D. Pa. 1987).
9
Richmond Leasing Co., 762 F.2d at 1309.
10
Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 MINN. L. REV.
439, 440 (1973).
4
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the Bankruptcy Code. Under this court’s guidance, our inquiry can stop
there.
Klairmont’s position is untenable, however, even under the test it
proposes we adopt from another circuit, under which courts should not defer
to a debtor’s decision under § 365 that is “the product of bad faith, or whim,
or caprice.”11 Klairmont misunderstands this standard, urging this court to
hold that any bad faith involved in the bankruptcy proceedings should prompt
a bankruptcy court to decline a debtor’s decision regarding an executory
contract. That is not the test these other courts have adopted. The authority
Klairmont cites states that the issue is “whether the decision of the debtor
that rejection will be advantageous is so manifestly unreasonable that it could
not be based on sound business judgment, but only on bad faith, or whim or
caprice.”12 Under this standard, too, the question revolves around benefit to
the debtor, not bad faith affecting third parties.
The other opinions Klairmont cites do not strengthen its argument.
To bolster support for its “bad faith” standard, appellant cites In re Pilgrim’s
Pride Corporation for the assertion that “[t]he business judgment rule does
not provide [debtors] unfettered freedom to use the power given by Code §
365(a) however they will.”13 Yet the bankruptcy court in that case
disapproved of the debtor’s action because the debtor rejected an executory
contract as retaliation against the third party, which was not a rational
11
In re Wheeling-Pittsburgh Steel Corp., 72 B.R. at 849.
12
Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1047
(4th Cir. 1985) (emphasis added). Klairmont quotes text from another case, the full text of
which reads, “whether the debtor’s decision that rejection will be advantageous to the estate
is so manifestly unreasonable that it could not be based on sound business judgment, but
only on bad faith, or whim, or caprice.” In re Wheeling-Pittsburgh Steel Corp., 72 B.R. at 849(emphasis added).
13
In re Pilgrim’s Pride Corp., 403 B.R. 413, 426 (Bankr. N.D. Tex. 2009).
5
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economic decision.14 Klairmont also cites In re Krueger in an attempt to
ground its contention in this court’s case law.15 That case concerned “bad
faith” as cause for dismissal of a bankruptcy action under § 707, given that
the debtor “abused bankruptcy and court processes to retain assets for
himself and defeat the legitimate claims of his business partners.”16 Those
circumstances bear little resemblance to the theory Klairmont asserts
regarding the business judgment rule.
It is true that bad faith dealing prejudiced Klairmont in its negotiations
with JCP for assumption of its sublease. There is no dispute in this case that
the real estate agent lied to Klairmont and impeded its dealings with the
debtor. Klairmont will not find relief, however, in asserting that JCP’s
decision deserves no deference under the business judgment rule.
The district court’s judgment is AFFIRMED.
14
Id. at 428.
15
In re Krueger, 812 F.3d 365 (5th Cir. 2016).
16
Id. at 366–67.
6