Pinnacle Restaurant at Big Sky, LLC v. CH SP Acquisitions, LLC , 862 F.3d 1148 ( 2017 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
IN THE MATTER OF SPANISH PEAKS No. 15-35572
HOLDINGS II, LLC,
Debtor. D.C. No.
2:14-cv-00040-
SEH
PINNACLE RESTAURANT AT BIG SKY,
LLC; MONTANA OPTICOM, LLC,
Plaintiffs-Appellants, OPINION
v.
CH SP ACQUISITIONS, LLC; ROSS P.
RICHARDSON, Ch. 7 Trustee,
Defendants-Appellees.
Appeal from the United States District Court
for the District of Montana
Sam E. Haddon, Senior District Judge, Presiding
Argued and Submitted April 6, 2017
Seattle, Washington
Filed July 13, 2017
2 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
Before: Alex Kozinski and William A. Fletcher, Circuit
Judges, and Frederic Block, District Judge.*
Opinion by Judge Block
SUMMARY**
Bankruptcy
The panel affirmed the district court’s judgment affirming
the bankruptcy court’s decision that a bankruptcy trustee’s
sale of a debtor’s property was free and clear of unexpired
leases.
Agreeing with the Seventh Circuit, the panel held that
11 U.S.C. § 363(f), authorizing a trustee to sell a debtor’s
assets free and clear of third-party interests, applied, and did
not conflict with § 365(h), which protects the rights of
lessees, because the trustee did not “reject” the leases.
*
The Honorable Frederic Block, Senior United States District Judge
for the Eastern District of New York, sitting by designation.
**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 3
COUNSEL
Mark A. Lindsay (argued) and David W. Ross, Babst Calland
Clements and Zomnir P.C., Pittsburgh, Pennsylvania, for
Plaintiffs-Appellants.
James F. Wallack (argued) and Peter D. Bilowz, Goulston &
Storrs PC, Boston, Massachusetts; Steven M. Johnson,
Church Harris Johnson & Williams P.C., Great Falls,
Montana; for Defendants-Appellees.
OPINION
BLOCK, Senior District Judge:
The primary function of the Bankruptcy Code is to set out
the rules for dividing up assets that are insufficient to pay a
debtor’s creditors in full. One such rule, contained in
11 U.S.C. § 363(f), authorizes a trustee in bankruptcy to
sell—with some exceptions and limitations—a debtor’s assets
free and clear of third-party interests. Another, contained in
11 U.S.C. § 365(h), empowers the trustee to “reject”—that is,
in effect, to breach—an unexpired lease of the debtor’s
property, but allows the lessee to retain any existing rights,
including possession of the property.
In this case, we are called upon to decide what happens
when property that the trustee proposes to sell is subject to
unexpired leases. We hold that, on the facts of this case,
section 363 applies and section 365 does not. We therefore
affirm the bankruptcy court’s conclusion that the sale was
free and clear of the leases.
4 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
I
A. Pre-Bankruptcy Background
Spanish Peaks was a 5,700-acre resort in Big Sky,
Montana, the brainchild of James J. Dolan, Jr., and Timothy
L. Blixseth. The project was financed by a $130 million loan,
which was secured by a mortgage and assignment of rents,
from Citigroup Global Markets Realty Corp. (“Citigroup”).
Citigroup later assigned the note and mortgage to Spanish
Peaks Acquisition Partners, LLC (“SPAP”).
A collection of interrelated entities owned the resort and
managed its amenities, including a ski club, a golf course, and
residential and commercial real-estate sales and rentals. At
issue here are two leases of commercial property at the resort.
In 2006, Spanish Peaks Holdings, LLC (“SPH”), leased
restaurant space to Spanish Peaks Development, LLC
(“SPD”), for $1,000 per month. Dolan was an officer of both
companies, and signed the lease for both lessor and lessee. A
year later, SPH and SPD replaced the 2006 lease with a lease
under which SPD received a 99-year leasehold in the
restaurant property in exchange for $1,000 per year in rent.
In 2008, SPD assigned its interest to The Pinnacle Restaurant
at Big Sky, LLC (“Pinnacle”), a company specially created
for that purpose.
In 2009, SPH leased a separate parcel of commercial real
estate at the resort to Montana Opticom, LLC (“Opticom”),
of which Dolan was the sole member. The lease had a term
of sixty years and an annual rent of $1,285.
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 5
B. Bankruptcy Proceedings
Facing a shrinking real-estate market and mounting
operational losses, SPH began to default on its loan
payments. On October 14, 2011, SPH and two related
entities—The Club at Spanish Peaks, LLC, which managed
the resort’s ski and golf facilities, and Spanish Peaks Lodge,
LLC, which managed its real-estate sales—petitioned for
bankruptcy protection under Chapter 7 of the Code.1 The
petitions were filed in Delaware, but the proceedings were
transferred to the Bankruptcy Court for the District of
Montana, where they were consolidated for joint
administration.
SPH’s largest creditor was, by far, SPAP, which had a
valid claim of more than $122 million secured by the
mortgage on the property. SPAP subsequently assigned its
interest to CH SP Acquisitions, LLC (“CH SP”).
The trustee and SPAP agreed to a plan for liquidating
“substantially” all of the debtors’ real and personal property.
Their stipulation contemplated an auction with a minimum
bid of $20 million. It further stated that the sale would be
“free and clear of all liens.”
1
By the time of the bankruptcy, the resort was operated by Spanish
Peaks Holdings II, LLC, a successor to SPH. We refer to both the original
and successor entities as “SPH.”
6 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
The trustee then moved the bankruptcy court for an order
authorizing and approving the sale.2 The trustee represented
that the proposed sale would be “free and clear of any and all
liens, claims, encumbrances and interests,” except for certain
specified encumbrances, and that other specified liens would
be paid out of the proceeds of the sale or otherwise protected.
The Pinnacle and Opticom leases were not mentioned in
either the list of encumbrances that would survive the sale or
the list of liens for which protection would be provided.
Noting the omission, both companies objected to “any effort
to sell the Debtors[’] assets free and clear of [their] leasehold
interests.” They argued that the Code gave them the right to
retain possession of the property notwithstanding the sale.
After a hearing, the bankruptcy court authorized the sale.
It did not rule on Pinnacle’s and Opticom’s objection.
Instead, further discussion of the claimed right to possession
was deferred to the hearing on the motion to approve the sale.
Both the auction and the approval hearing took place on
June 3, 2013. CH SP won the auction with a bid of $26.1
million. At the approval hearing, Pinnacle and Opticom
renewed their claim that they were entitled to retain
possession pursuant to their leases, and argued that language
in the proposed approval order providing that the sale would
be free and clear of those interests was inconsistent with their
claimed right. In response, CH SP’s principal testified that its
2
Bankruptcy procedure is nothing if not Byzantine. The trustee’s
motion sought two distinct orders: first, an order authorizing the trustee
to conduct the sale in accordance with specified procedures, and second,
an order approving the sale—that is, confirming that the sale conformed
to those procedures.
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 7
bid was contingent on the property being free and clear of the
leases, while the trustee testified that he did not “t[ake] a
position” on that issue.
On June 13, 2013, the bankruptcy court entered an order
approving the sale. Paragraph I of the order held that the sale
was free and clear of any “Interests,” a term defined to
include any leases “(except any right a lessee may have under
11 U.S.C. § 365(h), with respect to a valid and enforceable
lease, all as determined through a motion brought before the
Court by proper procedure).”
Both sides moved for clarification of the approval order.
Pinnacle and Opticom sought clarification that the order
preserved their rights under the leases, while CH SP sought
clarification that the order approved a sale free and clear of
those interests. The bankruptcy court denied having ruled
one way or the other, explaining that it would not consider the
issue until the parties had “file[d] an appropriate motion,
notice[d] the matter for hearing, and present[ed] their
evidence.”
The trustee then offered his version of an “appropriate
motion,” seeking leave to reject the Pinnacle and Opticom
leases on the ground that the subject property was no longer
property of the estate. CH SP, meanwhile, formally moved
for a determination that the property was free and clear of the
leases. Pinnacle and Opticom did not object to the trustee’s
motion, which was granted. They did, however, renew their
previous arguments as objections to CH SP’s motion.
After a two-day evidentiary hearing on that motion, the
bankruptcy court made the following findings of fact:
8 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
• Pinnacle had not operated a restaurant on the property
since 2011;
• Pinnacle’s rent was far below the property’s fair
market rental value of $40,000 to $100,000 per year;
• Opticom’s lease was not recorded;
• the leases were executed “at a time when all parties
involved were controlled by James J. Dolan”;
• the leases were the subject of bona fide disputes;
• Citigroup’s mortgage was senior to the leases; and
• the leases were not protected from foreclosure of the
underlying mortgage by subordination or non-
disturbance agreements.
It further observed that Pinnacle and Opticom had not
requested adequate protection for their leasehold interests
prior to sale, and had at no time provided any evidence that
they would “suffer any economic harm if their possessory
interests [we]re terminated.”
Based on those findings, the bankruptcy court—applying
what it called a “case-by-case, fact-intensive, totality of the
circumstances, approach”—held that the sale was free and
clear of the Pinnacle and Opticom leases. Pinnacle and
Opticom appealed to the district court, which affirmed.3 In a
3
In addition, Pinnacle and Opticom moved the bankruptcy court for
an order awarding them monetary compensation as “adequate protection”
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 9
brief opinion, the district court held that the sale extinguished
the leases because the foreclosure of a mortgage would, under
Montana law, terminate any leasehold interests junior to the
mortgage. This appeal followed.
II
The principal issue is whether the Pinnacle and Opticom
leases survived the sale of the property to CH SP.4 Because
that issue is ultimately one of statutory interpretation, we
review the bankruptcy court’s decision de novo. See Simpson
v. Burkart (In re Simpson), 557 F.3d 1010, 1014 (9th Cir.
2009); Robertson v. Peters (In re Weisman), 5 F.3d 417, 419
(9th Cir. 1993) (“We independently review the bankruptcy
court’s decision and do not give deference to the district
court’s determinations.”).
As we noted at the outset, the issue brings two sections of
the Code into apparent conflict. Section 363 authorizes the
trustee to sell property of the estate, both within the ordinary
for their “divested interests” in the property. The bankruptcy court never
ruled on that motion.
4
In reaching the merits, we reject CH SP’s argument that the case is
moot because the sale was approved and consummated. “The reversal or
modification on appeal of an authorization . . . of a sale or lease of
property does not affect the validity of a sale or lease under such
authorization to an entity that purchased or leased such property in good
faith, whether or not such entity knew of the pendency of the appeal,
unless such authorization and such sale or lease were stayed pending
appeal.” 11 U.S.C. § 363(m). By its terms, section 363(m) preserves the
validity of a sale challenged on appeal. Although Pinnacle and Opticom
seek a determination that their leaseholds survived the sale to CH SP, they
have not asked us to undo the sale. Therefore, the outcome of the appeal
will not affect the sale’s validity.
10 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
course of business, see 11 U.S.C. § 363(c), and outside it, see
id. § 363(b).5 Sales may be “free and clear of any interest in
such property of an entity other than the estate,” id. § 363(f),
but only if
(1) applicable nonbankruptcy law permits sale
of such property free and clear of such
interest;
(2) such entity consents;
(3) 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;
(4) such interest is in bona fide dispute; or
(5) such entity could be compelled, in a legal
or equitable proceeding, to accept a
money satisfaction of such interest.
Id. Upon the request of a party with an interest in the
property, the bankruptcy court “shall prohibit or condition
such . . . sale . . . as is necessary to provide adequate
protection of such interest.” Id. § 363(e).
Meanwhile, section 365 of the Code authorizes the
trustee, “subject to the court’s approval,” to “assume or reject
5
Sales in the ordinary course of business do not require prior notice
and court approval, while sales outside the ordinary course of business do.
Compare 11 U.S.C. § 363(c) with id. § 363(b). The sale of SPH’s
property was outside the ordinary course of business.
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 11
any executory contract or unexpired lease of the debtor.”
11 U.S.C. § 365(a). Subsection (h) makes special provision
for rejected leases under which the debtor is the lessor:
(i) if the rejection by the trustee amounts to
such a breach as would entitle the lessee
to treat such lease as terminated by virtue
of its terms, applicable nonbankruptcy
law, or any agreement made by the lessee,
then the lessee under such lease may treat
such lease as terminated by the rejection;
or
(ii) if the term of such lease has commenced,
the lessee may retain its rights under such
lease (including rights such as those
relating to the amount and timing of
payment of rent and other amounts
payable by the lessee and any right of use,
possession, quiet enjoyment, subletting,
assignment, or hypothecation) that are in
or appurtenant to the real property for the
balance of the term of such lease and for
any renewal or extension of such rights to
the extent that such rights are enforceable
under applicable nonbankruptcy law.
The crux of this dense statutory language is that the rejection
of an unexpired lease leaves a lessee in possession with two
options: treat the lease as terminated (and make a claim
against the estate for any breach), or retain any
rights—including a right of continued possession—to the
extent those rights are enforceable outside of bankruptcy.
12 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
The statutes frequently operate in isolation. Many
bankruptcies will involve a sale of property unencumbered by
a lease, and many will involve the rejection of a lease on
property that the trustee does not intend to sell. But when
both provisions come into play—that is, when the trustee
proposes to sell property free and clear of encumbrances, and
one of the encumbrances is an unexpired lease—federal
courts have addressed the resulting dilemma in different
ways.
A. The “Majority” Approach
Several bankruptcy courts have held that sections 363 and
365 conflict when they overlap because “each provision
seems to provide an exclusive right that when invoked would
override the interest of the other.” In re Churchill Props.,
197 B.R. 283, 286 (Bankr. N.D. Ill. 1996); see also In re
Haskell, L.P., 321 B.R. 1, 8–9 (Bankr. D. Mass. 2005); In re
Taylor, 198 B.R. 142, 164–66 (Bankr. D.S.C. 1996); cf. In re
LHD Realty Corp., 20 B.R. 717, 719 (Bankr. S.D. Ind. 1982).
Those courts—which constitute a majority of the courts to
have addressed the issue—hold that section 365 trumps
section 363 under the canon of statutory construction that
“the specific prevails over the general.” In re Churchill
Props., 197 B.R. at 288. They further reason that “the
legislative history regarding § 365 evinces a clear intent on
the part of Congress to protect a tenant’s estate when the
landlord files bankruptcy,” In re Taylor, 198 B.R. at 165
(citing S. Rep. No. 95-989, at 60 (1978), reprinted in
1978 U.S.C.C.A.N. 5787, 5846), and that the protection
“would be nugatory,” In re Churchill Props., 197 B.R. at 288,
if the property could be sold free and clear of the leasehold
under section 363.
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 13
B. The “Minority” Approach
The only circuit court to have addressed the issue reached
a different conclusion based exclusively on the statutory text.
In Precision Industries, Inc. v. Qualitech Steel SBQ, LLC (In
re Qualitech Steel Corp. & Qualitech Steel Holdings Corp.),
327 F.3d 537 (7th Cir. 2003), the Seventh Circuit observed
that “the statutory provisions themselves do not suggest that
one supersedes or limits the other.” Id. at 547.
The court then examined the scope of each statute.
Section 363, it reasoned, confers a right to sell property free
and clear of “any interest,” without excepting from that
authority leases entitled to the protections of section 365. See
id. Section 365, by contrast, has a more “limited scope”:
Section 365(h) . . . focuses on a specific type
of event—the rejection of an executory
contract by the trustee or debtor-in-
possession—and spells out the rights of
parties affected by that event. It says nothing
at all about sales of estate property, which are
the province of section 363.
Id.
Again focusing on the statutory text, the court noted that
lessees are entitled to seek “adequate protection” under
section 363(e). “Lessees . . . are therefore not without
recourse in the event of a sale free and clear of their interests.
They have the right to seek protection under section 363(e),
and upon request, the bankruptcy court is obligated to ensure
that their interests are adequately protected.” 327 F.3d at
548.
14 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
Based on the statutes’ different scopes, the court
concluded that they did not conflict:
Where estate property under lease is to be
sold, section 363 permits the sale to occur free
and clear of a lessee’s possessory
interest—provided that the lessee (upon
request) is granted adequate protection for its
interest. Where the property is not sold, and
the [estate] remains in possession thereof but
chooses to reject the lease, section 365(h)
comes into play and the lessee retains the
right to possess the property. So understood,
both provisions may be given full effect
without coming into conflict with one another
and without disregarding the rights of lessees.
Id.
C. Our Approach
We must “read the statutes to give effect to each if we can
do so while preserving their sense and purpose.” Watt v.
Alaska, 451 U.S. 259, 267 (1981). We can easily do so here.
Based on our reading—and, in particular, a proper
understanding of the concept of “rejection”—we agree with
the Seventh Circuit that sections 363 and 365 do not conflict.
Although undefined in the Code, a “rejection” is
universally understood as an affirmative declaration by the
trustee that the estate will not take on the obligations of a
lease or contract made by the debtor. See, e.g., Eastover
Bank for Sav. v. Sowashee Venture (In re Austin Dev. Co.),
19 F.3d 1077, 1082 (5th Cir. 1994). A sale of property free
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 15
and clear of a lease may be an effective rejection of the lease
in some everyday sense, but it is not the same thing as the
“rejection” contemplated by section 365.
In sum, section 363 governs the sale of estate property,
while section 365 governs the formal rejection of a lease.
Where there is a sale, but no rejection (or a rejection, but no
sale), there is no conflict.
In some circumstances, a trustee’s failure to act is deemed
a rejection. See 11 U.S.C. §§ 365(d)(1) (failure to assume or
reject residential lease within sixty days in liquidation
bankruptcy deemed a rejection), 365(d)(4)(A) (failure to
assume or reject nonresidential lease within 120 days deemed
a rejection if the debtor is the lessee). But those
circumstances are not present here, and the parties agree that
the Pinnacle and Opticom leases were not “rejected” prior to
the sale. Under our interpretation, then, section 365 was not
triggered.6
We base our interpretation principally on the reasons
given by the Seventh Circuit. To that court’s sound textual
analysis, we add the following observations to mitigate the
concern that an attempt to harmonize the two statutes
“arguably results in the effective repeal of § 365(h).” Dishi
& Sons, 510 B.R. at 704.
6
It is, of course, possible for a trustee to formally reject a lease and
then propose to sell the property subject to the (rejected) lease. See Dishi
& Sons v. Bay Condos, LLC, 510 B.R. 696, 704 (S.D.N.Y. 2014) (noting
that Qualitech “conveniently” dealt with a situation “where a free and
clear sale occurred without any formal assumption or rejection taking
place”). That is not what happened here, and so we have no occasion to
address the interplay between sections 363 and 365 in such circumstances.
16 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
First, we note the mandatory language of section 363(e).
A bankruptcy court must provide adequate protection for an
interest that will be terminated by a sale if the holder of the
interest requests it. Moreover, “adequate protection” includes
any relief—other than compensation as an administrative
expense—that will “result in the realization by such entity of
the indubitable equivalent” of the terminated interest.
11 U.S.C. § 361(3). In Dishi & Sons, the district court
concluded that adequate protection could take the form of
continued possession. See 510 B.R. at 711–12. Since
Pinnacle and Opticom did not ask for adequate protection
until after the sale had taken place—not, indeed, until they
had appealed to the district court, see supra note 2—the
question of what protection the bankruptcy court could have
or should have awarded is not before us. Still, we think it
worth mentioning that the broad definition of adequate
protection makes it a powerful check on potential abuses of
free-and-clear sales.
Second, we emphasize that section 363(f) authorizes free-
and-clear sales only in certain circumstances. The
bankruptcy court did not specify which circumstance justified
the sale in this case, stating only that Pinnacle and Opticom
“d[id] not dispute that at least one provision of § 363(f) was
satisfied.” We, on the other hand, focus on 11 U.S.C.
§ 363(f)(1), which authorizes a sale if “applicable
nonbankruptcy law permits sale of such property free and
clear of such interest.” 11 U.S.C. § 363(f)(1).
Under Montana law, a foreclosure sale to satisfy a
mortgage terminates a subsequent lease on the mortgaged
property. See Ruby Valley Nat’l Bank v. Wells Fargo
Delaware Trust Co., 317 P.3d 174, 178 (Mont. 2014);
IN THE MATTER OF SPANISH PEAKS HOLDINGS II 17
Williard v. Campbell, 11 P.2d 782, 787 (Mont. 1932).7 SPH’s
bankruptcy proceeded, practically speaking, like a foreclosure
sale—hardly surprising since its largest creditor was the
holder of the note and mortgage on the property. Indeed, had
SPH not declared bankruptcy, we can confidently say that
there would have been an actual foreclosure sale. Such a sale
would have terminated the Pinnacle and Opticom leases.
In Dishi & Sons, the district court held that section
363(f)(1) “refers not to foreclosure sales, but rather only to
situations where the owner of the asset may, under
nonbankruptcy law, sell an asset free and clear of an interest
in such asset.” 510 B.R. at 710 (citation and internal
quotations omitted). While we acknowledge that bankruptcy
protection is often sought “for the very purpose of avoiding
the less favorable consequences of foreclosure,” id. at 709,
the protection is generally for the debtor’s benefit. We find
it significant that section 365 recognizes appurtenant rights
conferred by a lease “to the extent that such rights are
enforceable under applicable nonbankruptcy law,” 11 U.S.C.
§ 365(h)(1)(A)(ii), and discern from that language a clear
intent to protect lessees’ rights outside of bankruptcy, not an
intent to enhance them. We see no reason to exclude the law
governing foreclosure sales from the analogous language in
section 363(f)(1).
Our analysis highlights a limitation inherent in the
“majority” approach. We agree that section 365 embodies a
7
Montana law embodies the general rule of property law, except that
Montana law allows the tenant to remain in possession during any period
of redemption, while under the general rule the lease terminates
immediately upon the sale. See Williard, 11 P.2d at 787. The distinction
is immaterial for our purposes.
18 IN THE MATTER OF SPANISH PEAKS HOLDINGS II
congressional intent to protect lessees. But that intent is not
absolute; it exists alongside other purposes and sometimes
conflicts with them. To some extent, protecting lessees
reduces the value of the estate—property presumably fetches
a lower price if it is subject to a lease—and is therefore
contrary to the goal of “maximizing creditor recovery,”
Qualitech, 327 F.3d at 548, another core purpose of the Code.
The statutory text is the best assurance we have that we are
balancing competing purposes in the way Congress intended.
III
Section 363(f)(1) authorized the sale of SHP’s property
free and clear of the Pinnacle and Opticom leases. Since the
trustee did not reject the leases, section 365 was not
implicated. Accordingly, the judgment of the district court is
AFFIRMED.