Interface Group-Nevada, Inc. v. Trans World Airlines, Inc.

Opinions of the United
1998 Decisions States Court of Appeals
for the Third Circuit
5-4-1998
In Re: Trans World v.
Precedential or Non-Precedential:
Docket 97-7116,97-7148
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Recommended Citation
"In Re: Trans World v." (1998). 1998 Decisions. Paper 100.
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Filed May 4, 1998
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 97-7116
IN RE: TRANS WORLD AIRLINES, INCORPORATED,
Debtor
INTERFACE GROUP-NEVADA, INCORPORATED,
Appellant
v.
TRANS WORLD AIRLINES, INCORPORATED
THOMAS E. ROSS,
Trustee
No. 97-7148
IN RE: TRANS WORLD AIRLINES, INCORPORATED,
Debtor
INTERFACE GROUP-NEVADA, INCORPORATED
v.
TRANS WORLD AIRLINES, INCORPORATED,
Appellant
THOMAS E. ROSS,
Trustee
On Appeal from the United States District Court
for the District of Delaware
(D.C. No. 94-cv-00593)
Argued October 27, 1997
Before: SLOVITER, NYGAARD and KRAVITCH,*
Circuit Judges
(Opinion Filed May 4, 1998)
P. Gregory Schwed (Argued)
Loeb & Loeb
New York, N.Y. 10154
Kevin Gross
Rosenthal, Monhait, Gross &
Goddess
Wilmington, DE 19899
Attorneys for Appellant/Cross-
Appellee
Ronald E. Barab (Argued)
Stephen M. Forte
Smith, Gambrell & Russell
Atlanta, GA 30309
William H. Sudell, Jr.
Derek C. Abbott
Morris, Nichols, Arsht & Tunnell
Wilmington, DE 19801
Attorneys for Appellee/Cross-
Appellant
OPINION OF THE COURT
SLOVITER, Circuit Judge.
Interface Group-Nevada, Inc. appeals from an order of the
United States District Court for the District of Delaware
entered in connection with the Chapter 11 proceeding of
Trans World Airlines, Inc. ("TWA") which rejected Interface's
_________________________________________________________________
* Hon. Phyllis A. Kravitch, Senior United States Circuit Judge for the
Eleventh Circuit, sitting by designation.
2
claim for interest on its administrative claims, rejected its
claim for liquidated damages, and rejected some of the
elements in its calculation of its actual damages. TWA
cross-appeals from the failure to dismiss Interface's
unsecured claim and from the calculation of Interface's
damages.
I.
The material facts underlying this appeal are not in
dispute. Interface, which is in the business of, among other
things, arranging and packaging vacation tours, purchased
two 1973 Lockheed L-1011s in 1988 from the
Manufacturer's Hanover Trust Company, which had been
leasing the planes to TWA. Interface paid a total of
$25,200,000 for the two planes, financing 100% of the
purchase price. By agreement dated March 22, 1988,
Interface then leased the planes to TWA. These two planes
lie at the center of this dispute.
Though TWA initially met its obligations under the lease,
it ceased paying rent on the two L-1011s sometime in late
1990 or early 1991. Interface brought suit and obtained an
order of attachment for the planes from a California state
court. Thereafter, negotiations between TWA and Interface
resumed and culminated in the execution of a new lease
dated May 1, 1991. Many of the terms of the 1991 lease
("the lease") remained unchanged from the prior terms.
Some changes were made, however, including a reduction
in the monthly rent from $175,000 to $160,000 per plane
and an extension of the lease term to January 31, 1996.
The new lease also added a provision entitling Interface to
withhold as a form of security deposit approximately
$1,478,000 that it owed to TWA for work that TWA had
performed on other Interface aircraft until TWA completed
a major maintenance overhaul (known as an "OP-16") on
the two L-1011s. In addition, the lease contained a
stipulation from TWA that the liquidated damages provision
contained in the original lease was valid, reasonable and
enforceable.
On January 31, 1992, TWA voluntarily filed for protection
in bankruptcy under Chapter 11 of the United States
3
Bankruptcy Code. Two months later, it defaulted on the
lease payments to Interface due April 1, 1992. Within days,
TWA moved for, and the bankruptcy court signed, an order
pursuant to 11 U.S.C. S 1110 ("the S 1110 agreement")
dated April 3, 1992 and effective March 31, 1992,
authorizing TWA to make whatever payments were
necessary to cure its past default and to continue to meet
its obligations coming due under the lease on or after
March 31, 1992. In addition, the order made clear that
TWA was not assuming the lease pursuant to section 365
of the Bankruptcy Code, but was retaining its right to
petition the court for an order authorizing either the
assumption or rejection of the lease in the future.
Pursuant to the S 1110 agreement, TWA cured its default
and continued to make all payments through September 1,
1992, covering the month ending September 30, 1992. TWA
made no payments after that, however, and went into
default. It then took the aircraft out of service as of October
24, 1992, but continued to use the Interface engines on
other planes in its fleet. On November 12, 1992, the
bankruptcy court granted TWA's motion to reject the lease.
Nevertheless, TWA did not make the aircraft available to
Interface until December 3, 1992. At that time, Interface
requested TWA to keep the two planes until after the
Christmas holiday, and took actual physical possession of
the aircraft on December 29 and 30, 1992.
TWA concedes that the planes were returned in worse
mechanical condition than required under the lease. After
repossessing the aircraft, Interface attempted to mitigate its
damages by either selling or leasing the planes, but there
had been a precipitous downturn in the airline industry,
and its efforts were unavailing. As a result, Interface was
forced to place the two L-1011s in long-term or "deep"
storage in Arizona.
On November 13, 1992, the day after TWA rejected the
lease, Interface filed a claim for administrative expenses
incurred as a result of TWA's breach of the S 1110
agreement and its rejection of the lease. Interface amended
its claim on September 23, 1993.
At the hearing in the bankruptcy court on Interface's
Motion for Immediate Payment of Administrative Rent,
4
Interface argued that it was entitled to the liquidated
damages provided for in the lease as a result of TWA's
breach. Interface contended that in the alternative it was
entitled to recover its actual damages for the loss of rent,
the return condition maintenance work not performed, and
the costs associated with its storage of the planes and
attempts to re-market them. All of these were sought as
administrative expenses.
In opposition, TWA first argued that Interface's
unsecured claim should be dismissed for Interface's failure
to file a proper proof of claim. After the bankruptcy court
rejected that argument, TWA contended, inter alia, that (1)
the liquidated damages provision was void as contrary to
public policy, (2) Interface's administrative claim should be
limited to lost rent for the period from October 1, 1992 to
October 24, 1992, the date that TWA allegedly took the
planes out of service, (3) Interface failed to mitigate its
damages, and (4) Interface's loss as a result of the condition
of the aircraft on return should be offset by the $1,478,000
security deposit it was holding for the OP-16 overhauls
TWA had been obliged to perform at a future date.
In a brief oral opinion, the bankruptcy court concluded
that (1) the liquidated damages provision was penal rather
than compensatory and, therefore, was unenforceable, (2)
Interface's attempt to mitigate its damages was sufficient,
(3) the planes, or at least their engines, were being used by
and were of value to TWA through December 3, 1992, (4)
Interface was entitled to administrative status on the rents
owing from October 1, 1992 through December 10, 1992,
(5) damages resulting from the return condition
maintenance deficiencies and from rents accruing after
December 10, 1993 were recoverable only as unsecured
claims, (6) the monthly rent recoverable would be $133,000
per plane as opposed to the $160,000 provided for in the
lease, (7) Interface was entitled to damages resulting from
TWA's maintenance deficiencies in the amount of
$1,175,149, and (8) the amount of Interface's unsecured
claim would be offset by the $1,478,000 "reserve
maintenance deposit" held by Interface.
The parties then submitted an order embodying the
bankruptcy court's rulings. The order, "approved as to
5
form" by counsel for Interface, granted Interface an
unsecured claim of $9,453,231 and an administrative claim
of $617,918, representing $133,000 per month per plane
from October 1, 1992 -- the date of the breach-- through
December 10, 1992. In addition, the order provided that
"Interface's Motion for Payment of Administrative Rent is,
except as resolved by the foregoing provisions of the Order,
hereby denied." App. at 581. The order was signed by the
bankruptcy court on September 8, 1994.
When the order was appealed to the district court, that
court first referred the matter to a magistrate judge, who
prepared a report and recommendation. Both parties filed
objections thereto in the district court. In a thorough
opinion, the district court reviewed the magistrate judge's
report and recommendation de novo and made the following
ten findings: (1) the bankruptcy court did not abuse its
discretion in permitting Interface to pursue a general
unsecured claim; (2) the proper time period for Interface's
administrative claim was from the date of the breach
through the date on which TWA made the planes available
to Interface or, in other words, October 1, 1992 through
December 3, 1992; (3) the bankruptcy court erred in
denying administrative expense status to the damages
flowing from TWA's failure to meet the return maintenance
conditions; (4) Interface's claim for unjust enrichment
concerning the maintenance conditions was meritless; (5)
the liquidated damages provision of the lease was
unenforceable; (6) the bankruptcy court did not err in
reducing the stream of future rents to their present value;
(7) Interface's request for interest on its administrative
claim was not properly presented to the bankruptcy court
or to the district court on appeal and, therefore, was
waived; (8) Interface's claim for "super-priority"
administrative treatment under 11 U.S.C. S 507(b) was
likewise waived; (9) Interface was entitled to an unsecured,
prepetition claim for its costs associated with storing the
aircraft after repossessing them; and (10) the bankruptcy
court erred in setting off the $1,478,000 OP-16 security
deposit against Interface's unsecured claim because TWA
had not performed an OP-16 overhaul on either plane.
On appeal, Interface contends that (1) the district court
erred in holding its claim for interest was waived, (2) the
6
lease's liquidated damages provision is enforceable because
it does not exact a penalty, and (3) the bankruptcy court's
award of actual damages was clearly erroneous because the
bankruptcy court (a) improperly reduced the amount of the
administrative monthly rent from $160,000 as provided in
lease to $133,000 and (b) improperly awarded Interface
$189,000 for only one "C" maintenance check while TWA
had failed to perform a "C" check on either plane in breach
of its obligations under the lease.
In its cross-appeal, TWA argues that (1) Interface's entire
unsecured claim should have been disallowed on account of
its failure to file a proper proof of claim, (2) the district
court erred in holding that the damages resulting from
TWA's failure to meet the return maintenance conditions
constituted an administrative expense, and (3) the district
court erred in refusing to permit TWA to offset the
$1,478,000 "maintenance deposit" against Interface's
recovery for the breach of the return condition provisions of
the lease.
II.
Because the district court sat as an appellate court
reviewing an order of the bankruptcy court, our review of
its determinations is plenary. In re Continental Airlines, 125
F.3d 120, 128 (3d Cir. 1997), cert. denied, 118 S. Ct. 1049(1998). "In reviewing the bankruptcy court's
determinations, we exercise the same standard of review as
the district court," Fellheimer, Eichen & Braverman, P.C. v.
Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir.
1995), that is, we review the bankruptcy court's legal
determinations de novo, its factual findings for clear error
and its exercise of discretion for abuse thereof. In re Engle,
124 F.3d 567, 571 (3d Cir. 1997) . We have jurisdiction
over the appeal pursuant to 28 U.S.C. S 158(d).
A.
We consider first whether the district court erred in
refusing to address Interface's request for interest on the
administrative portion of its claim. In declining to do so, the
district court stated that the bankruptcy court had not
7
addressed the issue, Interface had never explicitly
requested a ruling from the bankruptcy court, and Interface
"approved as to form" the bankruptcy court's order, which
did not include an award of interest. In addition, the
district court noted that, on appeal to it, Interface had not
listed the issue of its entitlement to interest on its
administrative claim in its Statement of Issues on Appeal
and had raised the issue only in the conclusion to its brief
in the district court. Thus, the court concluded that
Interface had waived the issue before both courts. In the
course of reaching this conclusion, the court highlighted
the novelty and complexity of the issue and recognized that
the various courts that have addressed it have taken
differing approaches and have reached different
conclusions. Noting also that the bankruptcy court had not
had the opportunity to apply its unique expertise in
deciding the issue, the district court declined to exercise its
discretion to address such a claim.
In order to put the issue of waiver in perspective, it is
necessary to review briefly the issue found to be waived.
Both the bankruptcy court and the district court had
granted Interface administrative status on the rents owing
from October 1, 1992 through early December, 1992, with
the district court reducing the end of the period from
December 10 to December 3. The district court, unlike the
bankruptcy court, held Interface was also entitled to an
administrative claim for its damages for TWA's failure to
return the planes in the condition specified in the leases.
These two figures constitute the administrative claim on
which Interface contends it was entitled to interest.
Entitlement to interest on an administrative claim is an
issue that this court has never addressed. As the district
court recognized, the question whether to award interest on
an administrative trade debt is an issue of considerable
complexity that has engendered a wide array of approaches
and conclusions in the courts. The Bankruptcy Code does
not expressly address the issue. As a result, courts have
attempted to resolve the issue by turning to pre-Code case
law, analogizing to the treatment of awards of interest on
tax claims and balancing the interests that animate much
of the Code -- namely, the necessity of encouraging
8
creditors to continue dealing with bankrupt debtors and the
often antagonistic concern not to deplete the estate through
excessive awards of high priority administrative claims. As
one of our sister circuits has stated "the diversity of
approaches indicates the complexity of the issue." In re
Colortex Indus., 19 F.3d 1371, 1377 (11th Cir. 1994)
(concluding that interest is recoverable on administrative
trade debts). But see In re United Trucking Serv., Inc., 851
F.2d 159, 164-65 (6th Cir. 1988) (noting division among the
courts and concluding that the allowance of interest is
usually not appropriate).
In this context we examine whether Interface fairly placed
the novel and complex claim of its entitlement to interest on
its administrative claim before the bankruptcy court and
the district court. Interface contends that it preserved its
claim for interest in the bankruptcy court both in its proof
of claim and in the proposed pretrial order. In its amended
proof of claim, Interface listed the administrative claim it
was seeking as "$22,517,867.00 (+ interest) [At least]." App.
at 72 (brackets in original) (emphasis added). Elsewhere in
its amended proof of claim, Interface again stated that it
was seeking an administrative claim in the amount of
"$22,517,867.00 (plus interest)" (emphasis added). There
was no reference to interest other than the two underlined
above. The proposed joint pretrial order states merely that
"Interface seeks interest and legal fees, as provided in the
Lease and by law." App. at 34. Interface contends that it
had no further opportunity to press its demand before the
bankruptcy court.
We have substantial question whether these slight
references really were sufficient to give the bankruptcy
court notice that Interface was seeking an award of interest
on the administrative claim. However, the bankruptcy court
itself, when reading from the proof of claim, noted at the
hearing that Interface claimed "$22,517,867, plus interest."
App. at 403. Although we believe the district court may
have reasonably concluded Interface did not give the
requisite notice of its claim to the bankruptcy court, in light
of Interface's reference to interest in both its proof of claim
and the joint pretrial order, and the bankruptcy court's
reference to the claim for interest, we prefer to rest our
9
holding on a different ground, i.e., Interface's failure to
preserve the issue in the district court.
Bankruptcy Rule 8006 requires a party appealing to the
district court to file a "statement of issues to be presented"
on appeal within ten days of the bankruptcy court order.
Fed. R. Bankr. P. 8006. Interface timely filed such a
statement and listed ten separate issues. Not one of those
issues contended that the bankruptcy court erred in failing
to award interest on the administrative claim.
Interface argues that the sixth issue listed, which asks
"[d]id the Bankruptcy Court err in limiting Interface's
administrative claim to only $617,918," is broad enough to
encompass its claim for interest. We do not agree. The issue
of the amount of the administrative claim and the issue of
whether interest is awardable on that claim are
conceptually distinct issues implicating very different
factual and legal analyses.
In addition to Rule 8006, Bankruptcy Rule 8010 is also
designed to assure that the district court is fully advised as
to the contentions of the party on appeal from the
bankruptcy court. Rule 8010 requires that all appellate
briefs filed in the district court contain a statement of the
issues presented, and requires that the argument section of
the appellant's brief "shall contain the contentions of the
appellant . . . ." Fed. R. Bankr. P. 8010(a)(1)(C),(E).
This rule was modeled after Rule 28 of the Federal Rules
of Appellate Procedure, see Fed. R. Bankr. P. 8010,
advisory committee notes, and, like Rule 28, "is not only a
technical or aesthetic provision, but also has a substantive
function--that of providing the other parties and the court
with some indication of which flaws in the appealed order
or decision motivate the appeal." In the Matter of Gulph
Woods Corp., 189 B.R. 320, 323 (E.D. Pa. 1995) (looking to
cases interpreting Rule 28 for guidance in interpreting Rule
8010). See also In re Suncoast Airlines, Inc., 188 B.R. 56,
58 n.2 (S.D. Fla. 1994) (same). Thus, a district court may,
in its discretion, deem an argument waived if it is not
presented in accordance with Rule 8010. See In re Brown
Family Farms, Inc., 872 F.2d 139, 142 (6th Cir. 1989). We
therefore review the district court's determination for abuse
of discretion. Id.10
As the district court correctly stated, Interface did not
mention the issue of the appropriateness of an award of
interest until the conclusion of its 40 page brief. The
conclusion read, in its entirety: "For the reasons stated
above, it is respectfully requested that Interface's claim be
allowed, as summarized in Schedule A, along with
attorneys' fees and interest." A footnote to the conclusion
then provided simply that "[i]nterest on administrative trade
debt is allowable as an administrative claim. In re Colortex
Indus., 19 F.3d 1371 (11th Cir. 1994)." Finally, the
schedule referenced in the conclusion stated in a footnote
that "[t]o the extent deemed administrative, all amounts
should bear interest (See ``Conclusion')."
In clear disregard of the mandate of Rule 8010, Interface
did not set forth the issue in a statement of issues
presented and did not reference this issue anywhere in the
argument section of its brief. Moreover, the scant references
to the issue that were made in the brief failed to specify
whether the bankruptcy court had awarded interest or had
discussed the issue to any extent. Indeed, the references in
the conclusion do not even suggest whether Interface was
asking the district court to affirm or reverse.
In light of this record, it is not surprising that the
magistrate judge, to whom the case was referred, failed to
make any reference to interest in her Report and
Recommendation to the district court. Thus, we cannot say
that when Interface raised this issue in its objections to
that Report, the district court abused its discretion in
holding that Interface had waived its request for interest on
its administrative claim.
When the district courts are sitting on appeal, they are
entitled to the same full exposition of the parties'
contentions that we have repeatedly insisted on for
ourselves. See Reynolds v. Wagner, 128 F.3d 166, 178 (3d
Cir. 1997) ("an argument consisting of no more than a
conclusory assertion . . . will be deemed waived");
(Southwestern Pa. Growth Alliance v. Browner, 121 F.3d
106, 122 (3d Cir. 1997) ("appellate courts generally should
not address legal issues that the parties have not developed
through proper briefing"); Commonwealth of Pa. v. HHS,
101 F.3d 939, 945 (3d Cir. 1996) (arguments mentioned in
11
passing but not squarely argued will be deemed waived)).
See also United States v. Voigt, 89 F.3d 1050, 1064 n.4 (3d
Cir.) ("The failure to raise a theory as an issue on appeal
constitutes waiver . . . [and] briefs must contain statements
of all issues presented for appeal, together with supporting
arguments. . .." (emphasis in original) (internal citations
omitted), cert. denied, 117 S. Ct. 623 (1996); Nagle v.
Alspach, 8 F.3d 141, 143 (3d Cir. 1993) ("When an issue is
either not set forth in the statement of issues presented or
not pursued in the argument section of the brief, the
appellant has abandoned and waived that issue on
appeal"); Lunderstadt v. Colafella, 885 F.2d 66, 78 (3d Cir.
1989) (a "casual statement" cannot serve to preserve an
issue on appeal where it is contained in neither the
statement of issues on appeal nor the argument section of
the brief).
Interface, apparently in recognition of the force of TWA's
waiver contention, argues that even assuming that the
issue had not been presented below, this court should
nevertheless reach and decide it because it is a pure legal
issue. In light of Interface's failure to raise the issue
appropriately in the district court, we decline to address it
here.
B.
Second, Interface argues that both the bankruptcy court
and the district court erred in holding the liquidated
damages clause in the lease to be unenforceable. The
liquidated damages provision provides:
SECTION 17. REMEDIES. Upon the occurrence of any
Event of Default . . . Lessor may, at its option, declare
this Lease to be in default and at any time thereafter,
. . . Lessor may do one or more of the following with
respect to all or any Aircraft as Lessor . . .
(c) . . . Lessor, by written notice to Lessee specifying a
payment date . . . , may demand that Lessee pay to
Lessor, on the payment date specified in such notice,
as liquidated damages for loss of a bargain and not as
a penalty . . . , (x) an amount equal to any unpaid
Monthly Rent for such Aircraft due for periods prior to
12
the Rental Payment Date specified in such notice plus
which ever of the following amounts Lessor, in its sole
discretion, shall specify in such notice . . . : (i) an
amount equal to the excess, if any, of the Termination
Value for such Aircraft, computed as of the Rental
Payment Date specified for payment in such notice,
over the aggregate fair market rental value . . . of such
Aircraft for the remainder of the Term for such Aircraft
after discounting such fair market rental value monthly
for the remainder of the Term . . . ; or (ii) an amount
equal to the excess, if any, of the Termination Value for
such Aircraft as of the date specified in such notice over
the fair market sales value . . . as of the Rental
Payment Date specified for payment in such notice.. . .
App. at 639 (emphasis added).
In addition, the lease states:
SECTION 18.2 WARRANTY AND ACKNOWLEDGMENT
OF VALIDITY OF THE LIQUIDATED DAMAGES
CLAUSE 17. TWA . . . herewith represents, warrants
and agrees that the liquidated damages clause found at
Section 17 of this New Lease (as was Section 17 of the
Old Lease) is valid, enforceable and negotiated at arms
length by parties of equal bargaining power, with the
harm difficult to estimate, and based on reasonable
valuations as known or possible in the future. TWA . . .
shall indemnify and defend Lessor, and each of its
successors, in the defense of Lessor's assertion of
Section 17.
App. at 702 (emphasis added).
The lease contains a choice of law provision calling for
the application of New York law. New York's law regarding
the enforceability of liquidated damages provisions is well-
defined. "A liquidated damages provision has its basis in
the principle of just compensation for loss" in the event of
breach. Truck Rent-A-Center, Inc., 361 N.E.2d 1015, 1018
(N.Y. 1977). As a general matter, such provisions are
enforceable "provided that the clause is neither
unconscionable nor contrary to public policy." Id. See also
LeRoy v. Sayers, 635 N.Y.S.2d 217, 222-23 (App. Div.
1995).
13
At the same time, the public policies of New York are
"firmly set against the imposition of penalties or forfeitures
for which there is no statutory authority." Truck Rent-A-
Center, Inc., 316 N.E.2d at 1018. Thus, the law has
developed that
[a] contractual provision fixing damages in the event of
breach will be sustained if the amount liquidated bears
a reasonable proportion to the probable loss and the
amount of actual loss is incapable or difficult of precise
estimation. . . . If however, the amount fixed is plainly
or grossly disproportionate to the probable loss, the
provision calls for a penalty and will not be enforced.
Pyramid Centres & Co., Ltd. v. Kinney Shoe Corp., 663
N.Y.S.2d 711, 713 (App. Div. 1997) (internal citations
omitted) (emphasis added).
Courts must apply this analysis from the parties'
perspective as of the date of the contract rather than from
the date of the breach, Truck Rent-A-Center, Inc., 361
N.E.2d at 1019, and must resolve all doubts in favor of a
construction that invalidates the provision as a penalty,
Pyramid Centres & Co., 663 N.Y.S.2d at 713.
Applying these standards, the bankruptcy court held that
the liquidated damages provision did not bear a reasonable
relationship to Interface's actual damages and was an
unenforceable penalty. In like vein, the district court
concluded that the liquidated damages provision of the
lease was unenforceable on the ground that actual damages
were easily calculable and the provision, when written, bore
no relation to Interface's anticipated actual damages. Dist.
Ct. Op. at 22-29.
Although the language of the liquidated damages
provision appears complex at first blush, its operation is
straightforward and depends upon the ascertainment of two
figures. One figure is the "termination value" of each
aircraft, which represents the predicted value for each
plane at specific dates in the future. This figure is
predetermined in the lease. The other figure is the fair
market rental value discounted to present value or the
resale value of the aircraft at the time of the breach. The
formula for liquidated damages set in S 17(c) is that, upon
14
breach, TWA would have to pay the predetermined
termination value less either the fair market rental value,
the option under S 17(c)(1), or the resale value, the option
under S 17(c)(ii).
The termination value set by the lease for each plane in
late 1992 was $13,500,000. From that figure would be
subtracted either the fair market rental value for the
remainder of the lease or the resale value as of October
1992. In late 1992, the airline industry was severely
depressed and Interface's expert estimated the resale value
of the planes to be $7,000,000 each and the fair market
rental value to be $5,314,116 (39 remaining payments at a
fair market rent of $100,000 per month). TWA's expert
arrived at similar, though slightly higher, figures.
We do not purport to explain what motivated the parties
to arrive at this formula for liquidated damages. As is
evident from the calculations above, they simply have no
bearing on Interface's probable loss in the event of breach.
Interface has never explained to this court, and certainly
not to the satisfaction of either the bankruptcy or district
court, why actual damages could not be ascertained upon
breach. Indeed, to approximate Interface's probable loss,
the parties needed only to total the remaining rental
payments plus the consequential or incidental damages
Interface was likely to incur in mitigating its damages or
storing the aircraft. As Interface forthrightly states,
however, "[t]hrough S 17(c), Interface sought to protect its
multi-million dollar aircraft investment by shifting to TWA
the risk of a market drop in the Aircraft's value. If TWA
defaulted during the Lease, and delivered to Interface
severely depreciated Aircraft, TWA would be responsible for
making up the difference." Interface Br. at 28.
To illustrate the effect of the liquidated damages
provision in S 17(c), albeit in an improbable hypothetical, if
TWA were to breach with one month remaining on the
lease, actual damages would be approximately one month's
rent per plane. Under S 17(c)(ii), however, TWA would owe
the termination value of $12,500,000 minus the resale
value at that time. Thus, using 1992 values, TWA would
owe $5,500,000 as liquidated damages per plane. Similarly,
under S 17(c)(i), TWA would owe the termination value of
15
$12,500,000 minus one month's rent of approximately
$100,000, for a total of $12,400,000 per plane.
We believe that New York's public policy is intended to
avoid precisely this type of penalty. See Truck Rent-A-
Center, Inc., 361 N.E.2d at 1018 ("A clause which provides
for an amount plainly disproportionate to real damage is
not intended to provide fair compensation but to secure
performance by the compulsion of the very disproportion. A
promisor would be compelled, out of fear of economic
devastation, to continue performance and his promisee, in
the event of default, would reap a windfall well above actual
harm sustained."); LeRoy, 635 N.Y.S.2d at 222-23 ("In
arriving at a stipulated sum as liquidated damages, there
must be some attempt to proportion damages to the actual
loss.").
Interface, citing S 18.2 of the lease, apparently would
have us disregard the requirement of proportionality
because TWA expressly agreed to the formula as valid and
enforceable. Specifically, Interface contends that TWA was
well represented and enjoyed equal bargaining power, that
TWA never objected to the reasonableness of the liquidated
damages provision or requested that it be taken out of the
lease and that consequently, it is "unseemly" for TWA now
to claim that the provision is unenforceable. Interface Br. at
24.
Although the district court initially expressed some
"concern" in light of S 18.2, ultimately it found that concern
was not enough to render an otherwise invalid provision
enforceable. Arguing to the contrary, Interface cites several
cases in which the courts have noted that the contracts at
issue containing a liquidated damages provision were freely
negotiated between parties with equal bargaining power. In
re United Merchants, 674 F.2d 134, 144 (2d Cir. 1982)
(applying New York law); Walter E. Heller & Co. v. American
Flyers Airline Corp., 459 F.2d 896, 899 (2d Cir. 1972)
(applying New York law); Rattigan v. Commodore Int'l, 739
F. Supp. 167, 172 (S.D.N.Y. 1990) (applying New York law).
See also Truck Rent-A-Center, Inc., 361 N.E.2d at 1019-20;
Leasing Serv. Corp. v. Justice, 673 F.2d 70, 74 (2d Cir.
1982) (applying New York law). In each of those cases,
however, the fact that the parties enjoyed equal bargaining
16
power was offered simply as additional support for
upholding a liquidated damages provision that was
otherwise reasonable and valid.
Interface does not cite any case in which a court enforced
an otherwise invalid liquidated damages provision merely
because it was freely negotiated by sophisticated parties.
Contracts that are void as against public policy are
unenforceable regardless of how freely and willingly they
were entered into. See Restatement (Second) Contracts Ch.
8, Intro. Note (1981) (public policy concerns "touch upon
matters of substance related to the public welfare rather
than aspects of the bargaining process between the
parties."); cf. Sternaman v. Metropolitan Life Ins. Co., 62
N.E.2d 763, 764 (N.Y. 1902) ("Parties cannot make a
binding contract in violation of law or of public policy.").
The mere fact that TWA warranted the enforceability of the
provision cannot negate the underlying public policy.
Accordingly, we will affirm the district court's order
holding that the liquidated damages provision contained in
the lease is unenforceable.
C.
Interface next challenges the amount of two items of
actual damages awarded to it.
1.
The bankruptcy court's order effective March 31, 1992,
granting TWA's application under S 1110 effectively
approved TWA's promise to continue to perform its
obligations to Interface under the lease. Nonetheless, when
the bankruptcy court included as an administrative
expense the monthly rent TWA owed for the period of
October 1, 1992 until early December, 1992, it reduced the
rent of $160,000 a month provided in the lease to
$133,000. The issue before us is whether, in the event of a
breach of a S 1110 agreement, the amount recoverable as
administrative rent should be the amount provided for in
the lease (here $160,000 per month), as Interface argues, or
the fair market rental value of the property at the time of
17
the breach, representing the objectively reasonable value to
the estate, as TWA argues. This presents an issue offirst
impression in this circuit, which implicates the scope of
S 1110 of the Bankruptcy Code.
To resolve the issue, we first must examine the
relationship among four different sections of the
Bankruptcy Code: SS 362, 365, 503 and 1110. Under
S 362(a), once a debtor files a petition in bankruptcy, an
automatic stay is imposed on claims against the debtor's
property. 11 U.S.C. S 362(a). Thus, if the debtor is
performing as lessee under an unexpired lease at the time
it files a Chapter 11 petition, the lessor subsequently
cannot enforce its rights under the lease against the debtor
until the automatic stay is lifted by the court or a plan of
reorganization is confirmed. See 11 U.S.C.S 362(c),(d).
Once the petition has been filed, S 365 allows a trustee or
debtor-in-possession, subject to court approval, to
"assume" or "reject" an unexpired lease at any time prior to
confirmation of the debtor's plan for reorganization. 11
U.S.C. S 365(a),(d)(2); see Sharon Steel Corp. v. National
Fuel Gas Distrib. Corp., 872 F.2d 36, 43 (3d Cir. 1989). If
the lease is assumed, i.e., the debtor and the court having
agreed that the continuation of the lease is in the best
interest of the debtor's reorganization and continuation, the
debtor is entitled to receive the benefits under the lease
but, at the same time, is responsible for performing its
obligations thereunder. In re Columbia Gas Sys. , 50 F.3d
233, 238-39 & n.8 (3d Cir. 1995). Should the debtor breach
thereafter, all future payments due under the remainder of
the lease become administrative expenses with
administrative priority. Id.If the lease is rejected, a creditor's claim for the stream of
future rental payments due under the now-rejected lease is
denied post-petition administrative status and is treated as
an unsecured prepetition claim. Id. at 238 n.8. Where the
debtor continued to use the leased property prior to
rejection, it is liable for the rental payments accruing
during the period of use, and that obligation is treated as
a S 503 post-petition administrative expense. However, the
amount treated as an administrative expense would not
necessarily be the rent provided for in the lease, since
18
administrative expenses are allowable only for "the actual,
necessary costs and expenses of preserving the estate." 11
U.S.C. S 503(b)(1)(A). Thus, it is well-settled that under
S 503 the debtor is responsible for only the fair market
value of the property at the time of its use.1 See generally
In re Zagata Fabricators, Inc., 893 F.2d 624, 627 (3d Cir.
1990); Sharon Steel Corp., 872 F.2d at 42-43.
Congress has provided a somewhat different scheme for
the airline industry. Under S 1110 of the Bankruptcy Code,
lessors of aircraft, inter alia, may avoid the automatic stay
and retake possession of the leased equipment unless the
airline takes certain required steps.
Section 1110 provides, in relevant part:
The right . . . of a lessor . . . of . . . aircraft . . . leased
to . . . a debtor that is an air carrier . . . to take
possession of such equipment in compliance with the
provisions of a . . . lease . . . is not affected by section
362 or 363 of this title or by any power of the court to
enjoin such taking of possession, unless--
(1) before 60 days after the date of the order for relief
under this chapter, the trustee [or debtor-in-
possession], subject to the court's approval, agrees to
perform all obligations of the debtor that become due on
or after such date under such . . . lease . . .
11 U.S.C. S 1110(a) (emphasis added). In addition, the
debtor must agree to cure all prior defaults and all future
defaults within 30 days of their occurrence. Id.As is evident, S 1110 subtly alters the interplay between
the provisions discussed above in the context of aircraft
and aircraft equipment financing. Section 1110 was
designed in part to increase availability of low-interest
capital to the transportation industry. See generally In re
Continental Airlines, Inc., 932 F.2d 282, 291 (3d Cir. 1991).
Toward this end, S 1110 renders S 362's automatic stay
effective for only 60 days following the filing of the petition
_________________________________________________________________
1. Because all relevant events underlying the instant appeal occurred
prior to 1994, this dispute is governed by the pre-1994 Code. We,
therefore, need not consider the 1994 amendments to SS 365 and 1110.
19
in bankruptcy. After that time, the lessor is free to
repossess the aircraft in the event of breach by the debtor
unless, within those 60 days, the debtor enters into what is
referred to as a "S 1110 agreement." If a S 1110 agreement
is executed, which requires court approval but not the
lessor's consent, the automatic stay remains in effect. In
return for this protection, the debtor or its trustee must
"perform all obligations of the debtor that become due on or
after such date [on which the S 1110 agreement is entered
into] under such . . . lease" and cure any prior or future
defaults. 11 U.S.C. S 1110(a).
The legislative history to S 1110 provides guidance as to
how its invocation affects the operation of the other
sections of the Code discussed above.
The House Report stated:
It should additionally be noted that under section
1110(a) the trustee or debtor in possession is not
required to assume the . . . unexpired lease under
section 1110; rather, if the trustee or debtor in
possession complies with the requirement of section
1110(a), the trustee or debtor in possession is entitled
to retain the aircraft or vessel subject to the normal
requirements of section 365.
124 Cong. Rec. H11102-03, p. 32405-06 (daily ed. Sept. 28,
1978). A S 1110 agreement, then, operates neither as an
assumption nor as a rejection of the entire lease, but
rather, obligates the debtor to perform the lease obligations
as they come due, in return for the protection of the
automatic stay. After the S 1110 agreement is made, the
debtor remains free to make a formal assumption or
rejection of the lease and, until that time or such time as
the S 1110 agreement is breached or terminated, the
automatic stay of S 362 remains in effect.
Against the backdrop of this statutory scheme, we turn
now to the question presented on appeal. That is, whether
Interface's administrative claim for the rental obligations
coming due after the S 1110 agreement was entered into
but before the planes were returned should be fixed at the
$160,000 monthly rent provided for in the lease or whether
20
it should be reduced to the fair market value as would a
typical administrative claim under S 503.
The statutory language itself suggests the former. Under
the terms of S 1110, if the debtor is to retain possession of
the aircraft and continue to reap the benefits of the
automatic stay, it must "agree[ ] to perform all obligations.
. . that become due. . . under such. . . lease ." 11 U.S.C.
S 1110(a) (emphasis added). Interface argues that the
phrase "under such . . . lease" indicates Congress's
intention to bind the debtor to the terms of its lease, a
reading supported by the legislative history to S 1110.
There, Congress made clear that
[t]he sections [1110 and its companion statute 1168,
pertaining to railroad rolling stock] protect the interest
of the financer by entitling him to payments according
to the financing agreement terms or to his equipment.
They protect the estate and the reorganization process
by leaving the choice of which the financer will get to
the trustee. Thus, equipment that the trustee needs to
keep operating the business is beyond reach by the
financer if the trustee is willing to continue to pay for it
according to pre-bankruptcy terms. If the trustee does
not need the equipment, he may simply surrender it to
the financer.
H. R. Doc. No. 95-595, at 239 (1977), reprinted in 1978
U.S.C.C.A.N., 5963, 6199 (emphasis added). See also 7 L.
King, Collier on Bankruptcy P 1110.04 p. 1110-25 (15th ed.
Rev. 1997). In addition, Congress indicated that lessors of
equipment subject to a S 1110 agreement are assured the
same protection as are other lessors after a lease is
assumed by the debtor. H. R. Doc. No. 95-595, at 240,
reprinted in 1978 U.S.C.C.A.N. at 6199. That is, the lessor
is entitled to "payments under the terms of the lease." Id.In our view, these passages leave little doubt that under a
S 1110 agreement, the lessor is entitled to the full rent
provided for in the lease.
The only other circuit to have addressed a somewhat
similar issue reached a similar conclusion. In In re Airlift
Int'l, Inc., 761 F.2d 1503, (11th Cir. 1985), the question
presented was whether the financer, GATX Leasing Corp.,
21
was entitled to receive the amounts due under the terms of
its agreement with the debtor-lessee or the value of the
actual use of the aircraft to the debtor. The court
determined that, in the context of a S 1110 agreement, the
lessor was entitled to the full amount provided for under
the terms of the agreement. Id. at 1511 ("The amount of the
administrative claim is determined by looking to the
amount due under the agreement."). The court in Airlift did
not directly address the possibility of awarding the fair
market value.
Neither the bankruptcy nor district court in this case
held that Interface's recovery should be limited to the value
of TWA's actual use of the aircraft, and TWA does not urge
that position on appeal. Thus, although Interface relies on
Airlift almost exclusively, its holding is not directly apposite.
Nevertheless, the Eleventh Circuit's general approach to
the issue is illuminating. That court conceived of a S 1110
agreement as a post-petition agreement to meet prepetition
obligations. Id. at 1509. Typically, post-petition contracts in
the ordinary course of business may be entered into by the
debtor without prior court approval. Therefore, in order to
protect the estate from depletion through the enforcement
of unnecessary or deleterious post-petition contracts, an
administrative claim based on a post-petition contract is
subject to the court's power under S 503 to reduce the
amount of the claim to the reasonable value of the
contract's benefit to the estate. Id. at 1509 n.5. Similarly, in
the context of unexpired leases, a bankruptcy court will not
have had the opportunity to verify that the terms of an
unexpired lease are in fact actual and necessary expenses
of the estate prior to the debtor's formal assumption or
rejection. Thus, if the debtor rejects the lease, the court
may award an administrative claim for the post-petition
rents of less than the lease terms if it determines that those
terms are significantly disproportionate to the market rates
that the debtor could have obtained at the time the petition
in bankruptcy was filed.
A S 1110 agreement, however, can be entered into only
after a court has determined that the lease obligations
represent actual and necessary costs to the estate.
Accordingly, having received court approval ex ante, there
22
is no need to subject the agreement to the court's review for
a second time upon the submission of a creditor's claim. Id.
at 1509, 1510 n.5. TWA's S 1110 agreement was reviewed
and approved by the bankruptcy court as being "in the best
interests of TWA, its creditors and its estate." App. at 7.
Thus, the purpose of S 503 review by the bankruptcy court
was fulfilled at that time, and we read SS 503 and 1110 as
erecting no further barriers to Interface's receipt of the full
rental amounts provided in the lease.2
In determining the post-breach monthly rent to which
Interface was entitled, the bankruptcy court reduced the
monthly rent for the relevant period from $160,000, as
provided for in the lease, to $133,000, which was the figure
provided by TWA's expert as the fair market rental value of
the aircraft in 1992. The district court did not alter that
figure. We hold that both courts erred as a matter of law in
not awarding Interface an administrative claim for the lease
amount of $160,000 per month for the period of October 1,
1992 through December 3, 1992.
2.
Interface also argues that the bankruptcy and district
courts erred when calculating its actual damages because
they did not include damages for TWA's failure to perform
a timely "C" check on one of the two aircraft. Section 5(c)
of the lease provides that
Upon the return of any Aircraft including at the end of
the Term with respect thereto, Lessee shall have had
with respect to such Aircraft, at its own expense, a "C"
check or its functional equivalent completed within 45
days prior to the return of such Aircraft.
_________________________________________________________________
2. In response to Interface's suggestion that we follow the Eleventh
Circuit's reasoning, TWA attempts to distinguish Airlift on the ground
that GATX had voluntarily entered into and consented to the S 1110
agreement with the debtor whereas here, TWA entered into the
agreement and obtained court approval to assume the obligations under
the lease without Interface's consent. TWA's Br. at 33-35. We believe this
is a distinction without a difference and find no reasoned justification
for
conditioning a creditor's entitlement to full payment on whether or not
it consented to the formation of the S 1110 agreement.
23
App. at 662. A "C" check is a standard aircraft maintenance
overhaul which, according to the parties' joint pretrial
order, would have cost TWA $189,000.
TWA stipulated that it performed its last "C" check for
aircraft no. N31011 on July 17, 1992 and for aircraft no.
N41012 on September 28, 1992. In addition, the district
court found, and neither party disputes here, that the
"return date," or more precisely, the date on which TWA
made the aircraft available to Interface, was December 3,
1992. Thus, while the lease called for "C" checks to be
performed within 45 days of the return date, in fact they
were performed 139 days and 66 days prior to the return of
the aircraft.
For reasons not fully explained, the bankruptcy court
granted Interface damages for only one "C" check in the
amount of $189,000, and the district court did not alter
that determination. Interface argues that it is plainly
entitled to damages for TWA's failure to perform a"C" check
on the second plane within 45 days of its return, as
required under the lease. In opposition, TWA contends that
Interface waived this argument on appeal to the district
court and that the bankruptcy court's award was not
clearly erroneous because, according to TWA, Interface
suffered no harm as the required "C" check was performed
on that plane only 66 days prior to the date it was made
available.
With respect to the alleged waiver, TWA contends that in
Interface's appeal to the district court it had argued only
that the bankruptcy court had erred in calculating its
actual damages, without specifically drawing attention to
the "C" check issue. We are not persuaded by TWA's waiver
argument. Interface's inclusion in the Statement of Issues
on Appeal that the bankruptcy court erred in calculating its
actual damages is broad enough to encompass the various
instances in which Interface's damages might have been
underestimated. Moreover, in the argument section of its
opening brief submitted to the district court, Interface
argued that the bankruptcy court erroneously awarded it
only a portion of its damages flowing from TWA's failure to
meet the return maintenance requirements contained in S 5
of the lease. Thereafter, Interface pressed the specific issue
24
of the second "C" check in its reply memorandum,
describing its actual damages as "including a clearly
overdue ``C' check." Although Interface could have made a
more detailed argument, we cannot say that the issue was
waived.
TWA next argues that Interface was not harmed by its
failure to perform the second "C" check within 45 days of
the return date and, therefore, that TWA should not be
required to pay damages. However, the bankruptcy court
made no finding that Interface suffered no harm. Indeed,
contrary to TWA's argument, its expert did not testify to
that effect.
The bankruptcy court appears to have rejected the claim
for the second "C" check on the ground it had not come due
by the date TWA rejected the lease. However, the lease
required TWA to perform the "C" check within 45 days of
the planes' return. TWA's expert agreed the "C" check was
not performed within 45 days of the second plane's return.
Accordingly, we must conclude that both the bankruptcy
and district courts erred in failing to award Interface
$189,000 for the second "C" check which was not
performed in compliance with the lease.
D.
To conclude, on Interface's appeal we will (1) affirm the
district court's conclusion that Interface failed to preserve
its claim for interest on its administrative claim, (2) affirm
the district court's conclusion that the liquidated damages
provision contained in the lease is unenforceable under
New York law, (3) reverse the district court's decision,
which had adopted the bankruptcy court's decision, to
grant Interface's administrative claim for monthly rent in
the amount of $133,000 per plane and direct that Interface
be granted rent in the full lease amount of $160,000 per
plane from October 1, 1992 through December 3, 1992,
and (4) reverse the district court's decision, which had
effectively adopted the bankruptcy court's decision, denying
Interface additional damages of $189,000 for TWA's failure
to perform a timely "C" check on the second aircraft, and
direct that its claim be increased by that amount. We turn
to consider the cross-appeal.
25
III.
A.
TWA raises three issues in its cross-appeal. First, it
argues that the district court erred in affirming the
bankruptcy court's denial of TWA's motion to dismiss
Interface's unsecured prepetition claim as untimely.
Interface filed its "Amended Administrative Proof of
Claim" on September 23, 1993, well before the bar date of
December 3, 1993 (the last day on which unsecured claims
could be filed). However, it had not filed an unsecured
claim as such. At the close of Interface's case before the
bankruptcy court, TWA moved to dismiss Interface's entire
unsecured claim on the ground that Interface hadfiled only
an administrative claim and that the unsecured claim had
not been filed in time. Interface responded that its
September 23, 1993 filing was sufficient to constitute an
unsecured proof of claim, that TWA was on notice of
Interface's intent to pursue an unsecured claim in the event
that its claim or any part thereof was denied administrative
expense status, and that TWA had been treating Interface's
entire claim as a Class 8 unsecured claim since the claim
had been filed. In addition, Interface cross-moved before the
bankruptcy court for leave to amend its proof of claim if the
court deemed it necessary.
The bankruptcy court ruled as follows:
The Court is [ ]well-aware of the liberal amendment
rules. The sections of the Bankruptcy Code provide
that an administrative expense claim may be requested
and thus a proof of claim is not required for an
administrative expense request. If there is to be a claim
under Section 501, I believe it is, there must be a proof
of claim filed if, in fact, the debtor's schedules show
that claim as being disputed.
And what we have in Exhibit 41 [Interface's amended
proof of claim filed Sept. 9, 1993] is kind of a
bastardized claim. It indicates that it is an amended
administrative claim. It also checked that there's an
unsecured priority claim, which is questionable as to
what was meant by that.
26
* * *
This Court has found that when an administrative
claim is disallowed that that portion for breach of
contract becomes an unsecured claim. Thus, I cannot
grant the motion to dismiss.
App. at 402-04. The district court affirmed on the ground
that TWA "had notice of the substance of Interface's claim
and recognized that the claim might be treated as a
general, unsecured obligation." Dist. Ct. Op. at 9-10.
Bankruptcy Rule 7015 provides that amendments to
claims shall be governed by Rule 15 of the Federal Rules of
Civil Procedure, Fed. R. Bankr. P. 7015, which commits the
decision to grant or deny leave to amend to the trial court's
sound discretion. See generally Coventry v. United States
Steel Corp., 856 F.2d 514, 518 (3d Cir. 1988).
On appeal, TWA does not argue that it was prejudiced by
the bankruptcy court's allowance of Interface's unsecured
claim but rather that because no proper unsecured claim
had been filed before the bar date, any amendment of the
original claim or allowance of the unsecured claim would be
improper. As the bankruptcy court found, however,
Interface's "bastardized" proof of claim was ambiguous in
that it mentioned both an administrative proof of claim and
an unsecured priority claim. App. at 403. As such, we agree
with both the bankruptcy and district courts that
Interface's proof of claim had put TWA on notice that an
unsecured claim had been made against it and could be
pursued. Thus, there is nothing in the record to suggest
that the bankruptcy court's allowance of Interface's
unsecured claim was an abuse of discretion. Cf. In re
Burlington Coat Factory Sec. Lit., 114 F.3d 1410, 1434 (3d
Cir. 1997) (among the grounds justifying denial of leave to
amend are undue delay, bad faith, dilatory motive,
prejudice and futility); Hatzel & Buehler, Inc. v. Station
Plaza Assocs., 150 B.R. 560, 562 (Bankr. D. Del. 1993)
(amendment of a claim under Fed. R. Bankr. P. 7015
should be granted where the purpose is to cure a defect in
the claim as originally filed, to describe the claim with
greater particularity or to plead a new theory of recovery on
the facts set forth in the original claim). We will affirm both
the bankruptcy court and the district court on this issue.
27
B.
TWA next contends that the district court erred in
holding that the damage flowing from TWA's failure to meet
the return maintenance conditions provided for in the lease
would be treated as an administrative claim, thereby
reversing the bankruptcy court's determination that it was
a prepetition unsecured claim. There is little precedent to
help resolve this difficult issue.
Section 5 of the lease specified in detail the condition in
which the two L-1011 aircraft were to be returned to
Interface. TWA concedes that it failed to meet that
requirement. Accordingly, the only question before us is
whether TWA's failure to meet the lease's return condition
terms gives rise to an administrative rather than an
unsecured claim.
TWA reasons that this obligation did not come due before
November 12, 1992, the date it rejected the lease, and thus
its failure to meet the return conditions requirements
should be treated as an unsecured prepetition claim. The
bankruptcy court agreed, relying on its opinion in In re
Continental Airlines, Inc., 146 B.R. 520 (Bankr. D. Del.
1992), which held that once a lease is rejected, the debtor
is no longer bound by its terms. Under In re Continental
Airlines, return obligations arising after rejection would only
give rise to an administrative claim if the debtor's failure to
meet the conditions conferred an actual benefit on the
estate. Id. at 527-28. One court of appeals has reached a
contrary conclusion. In In re United Trucking Service, Inc.,
851 F.2d 159 (6th Cir. 1988), the Sixth Circuit held that
the lessee's failure to meet return conditions benefits the
estate in the amount that the debtor/lessee would have to
pay to meet those conditions and, therefore, the lessor's
claim for resulting damages should be given administrative
priority. Id. at 162.
In the case before us, the district court reversed the
holding of the bankruptcy court on the classification of the
return maintenance conditions. The district court noted
that in neither In re Continental Airlines nor In re United
Trucking Service, had the debtor formally entered into a
S 1110 agreement. Dist. Ct. Op. at 16 n.9. That distinction
28
is critical. After TWA entered into the S 1110 agreement, the
extent of its duty to perform its obligations under the lease
and the ramifications of its failure to do so were controlled
by the operation of the S 1110 agreement and by S 1110
itself. See Airlift, 761 F.2d at 1513 ("[t]hough the Note set
the parameters of Airlift's obligation, it is the section 1110
agreement that creates the binding contractual obligations
of Airlift"). Therefore, cases in which the debtor did not
enter into a S 1110 agreement do little to inform our
analysis.
TWA's argument that its obligation under the S 1110
agreement ceased when it rejected the lease would stand on
somewhat better ground if it had returned the aircraft
immediately upon rejection, which it failed to do.
Ultimately, however, even then its argument would fail
because of the nature of the return condition obligation.
As we held above, as long as the debtor retains the leased
property without assuming the lease, it must meet its
obligations coming due in accordance with the strictures of
S 1110. Cf. In re Airlift, 761 F.2d at 1512 ("If the debtor
wishes to stop the payment meter [under a S 1110
agreement], he must return the aircraft . . . ."); 7 L. King,
Collier on Bankruptcy P 1110.05[2][a] p. 1110-36 (15th ed.
1997) ("if the obligation that the trustee agrees to perform
under section 1110 is an obligation owing pursuant to a
lease or executory contract, the trustee's agreement to
perform should be enforceable until the time that the
trustee formally rejects the lease or contract and
surrenders possession").
If the lease obligations are not met, such failure
constitutes a breach of the S 1110 agreement giving rise to
an administrative claim. One of the lease obligations
encompassed in the S 1110 agreement was the obligation
under the lease to return the planes in a specified
condition. Although the obligation fell due on a specific
date, i.e., upon return, it accrued throughout the period of
the lease which covered TWA's use of the airplanes during
the course of its bankruptcy. It follows that when TWA
returned the planes, they had to be in the condition
required by the lease. See generally Kathryn Hoff-Patrinos,
Aviation Finance Revisited: The 1994 Amendments to
29
Section 1110 of the Bankruptcy Code, 69 Am. Bankr. L. J.
167, 199-200 & n. 144 (1995) (concluding that under a
S 1110 agreement, a debtor's failure to meet maintenance
and return conditions should be treated as an
administrative expense).
Thus, the return condition requirement arose while the
S 1110 agreement was in effect and the district court did
not err in holding that the damages flowing from TWA's
failure to meet those conditions should have been afforded
administrative priority.
C.
TWA's final contention on its cross-appeal is that the
district court erred in reversing the bankruptcy court's
decision to offset the amount of Interface's damages
resulting from TWA's failure to meet the lease's return
maintenance requirements by the $1,478,000 security
deposit that Interface held.
Section 33 of the lease authorized Interface to withhold
$1,478,000 that it owed to TWA and to retain that sum as
a "maintenance deposit" to be returned to TWA without
interest upon TWA's "completion of an OP-16 overhaul . . .
on both Aircraft." App. at 708. Under TWA's FAA-approved
maintenance program, each overhaul in a progression of
increasingly more thorough or "heavier" maintenance
overhauls must be performed after a specified number of
flight hours. Under S 5(d) of the lease, if a plane, when
returned to Interface, was more than 75% of the way to
needing the next heaviest overhaul TWA was required to
perform that overhaul, even if it would have otherwise been
premature.
It is undisputed that OP-16 overhauls would have cost
TWA over $2,000,000 per plane. It is also undisputed that
TWA never performed an OP-16 overhaul on either aircraft.
TWA argues that it is entitled to a setoff in the amount of
the deposit because an OP-16 overhaul never came due
under TWA's FAA-approved maintenance plan. In response,
Interface cites the plain language of S 33 and argues that
because the OP-16 overhauls were never performed, it is
entitled to retain the security deposit.
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Without discussion, the bankruptcy court reduced the
amount of Interface's award of damages for TWA's failure to
meet the return conditions by the amount of the OP-16
deposit. The district court reversed and concluded that,
given the unambiguous language of S 33, Interface was
entitled to retain the entire security deposit because TWA
had not performed an OP-16 overhaul on either aircraft.
Dist. Ct. Op. at 37. We agree. The $1,478,000 was not a
general security deposit to protect Interface in the event
that TWA failed to meet the return maintenance
requirements. Rather, it was a specific deposit, tied only to
the performance of the OP-16 overhauls. Whether Interface
is entitled to retain the deposit is analytically distinct from
and should have no bearing on Interface's recovery for
TWA's failure to meet the various return conditions other
than the performance of the OP-16 overhauls.
Nothing on the face of S 33 suggests that Interface would
have a duty to return the security deposit if TWA were to
return the planes before the OP-16 overhauls were due.
Thus, S 33 not only protected Interface in the event that
TWA failed to perform OP-16 overhauls that were overdue,
but shifted to TWA the risk of having to pay for the OP-16
overhauls when due in the future. For example, in the
absence of a lease provision such as S 33, if TWA returned
the planes immediately before the OP-16 overhauls became
due under S 5 of the lease, Interface would have been left to
bear the entire cost of the overhauls. Section 33 assured
Interface that, in the event of early termination, TWA would
bear at least some responsibility for the cost of the
overhauls.
Because S 33 reflected a reasonable estimate, ex ante, of
the injury that Interface would incur if TWA terminated the
lease early, S 33 did not constitute an unenforceable
penalty under New York law. See Pyramid Centres & Co.,
Ltd. v. Kinney Shoe Corp., 663 N.Y.S.2d 711, 713 (App. Div.
1997) (stating that a liquidated damages clause is
enforceable if it bears a reasonable proportion to the
probable loss and if the amount of the actual loss is
difficult to estimate).
Under S 33, the return of the deposit was conditioned on
TWA's performance of the OP-16 overhauls and that
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condition was never satisfied. Accordingly, Interface is
entitled to retain the deposit and the district court did not
err in reversing the bankruptcy court's order setting off
Interface's recovery against it.
D.
To conclude, on TWA's cross-appeal, we will (1) affirm the
district court's denial of TWA's motion to dismiss Interface's
unsecured claim as untimely filed, (2) affirm the district
court's grant of administrative status to Interface's claim for
damages flowing from TWA's failure to meet the return
conditions, and (3) affirm the district court's decision that
TWA was not entitled to offset the $1,478,000 maintenance
security deposit held by Interface against Interface's
recovery.
We will remand this case to the district court for action
in accordance with this opinion. Each party to bear its own
costs.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
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