Restaurant Co. v. United Leasing Corp.

Present: Hassell, C.J., Lacy, Keenan, Koontz, Kinser, and
Lemons, JJ., and Compton,∗ S.J.
RESTAURANT COMPANY, ET AL.
v. Record No. 051451 OPINION BY JUSTICE CYNTHIA D. KINSER
April 21, 2006
UNITED LEASING CORPORATION
FROM THE CIRCUIT COURT OF HANOVER COUNTY
John R. Alderman, Judge
In this appeal, we decide what effect, if any, the
assumption of an unexpired lease in a Chapter 11 bankruptcy
plan had on the running of the statute of limitations with
regard to obligations under surety agreements. Because
assuming an unexpired lease in bankruptcy did not create a
new obligation between the parties to the original lease,
we find that the statute of limitations as to the sureties’
obligations began to run from the time of the principal
obligor’s initial default and did not commence anew when
the Chapter 11 bankruptcy plan was confirmed. Thus, we
will reverse the judgment of the circuit court.
I. RELEVANT FACTS AND PROCEEDINGS
Havana ’59, Ltd. (Havana) opened a restaurant in
Richmond, Virginia in 1994. As part of its business
operations, Havana entered into four equipment lease
∗
Senior Justice Compton participated in the hearing
and decision of this case before his death on April 9,
2006.
agreements with United Leasing Corporation (United). The
lease agreement at issue in this appeal bears the date of
September 21, 1994 and has the designation of “Lease No.
3084.”1 In that agreement, Havana leased from United
“Restaurant Equipment, Furniture and Smallwares.”
In two separate but identical documents, each titled
“GUARANTY,” The Restaurant Company and Rochelle Holding
Company (the Sureties), guaranteed the performance of
Havana’s obligations under Lease No. 3084.2 In pertinent
part, each agreement stated:
[T]he Undersigned [meaning The Restaurant Company
in one agreement and Rochelle Holding Company in
the other agreement] jointly and severally
unconditionally guarantee to [United] the full
and prompt performance by [Havana] . . . of all
obligations which [Havana] presently or hereafter
may have to [United] and payment when due of all
sums presently or hereafter owing by [Havana].
For the purpose of this guaranty and
indemnity, all sums owing to [United] by [Havana]
shall be deemed to have become immediately due
and payable if (a) [Havana] defaults in any of
its obligations to [United]; (b) a petition under
1
In addition to Lease No. 3084, Havana also entered
into Lease No. 3083 in September 1994. Havana executed the
third lease, Lease No. 4210, in October 1995. Finally,
Havana entered into the fourth lease, Lease No. 4536, in
September 1997.
2
As with Lease No. 3084, the Sureties executed
separate agreements guaranteeing the performance of
Havana’s obligations under Lease No. 3083. Michael J.
Ripp, the president and one of the owners of Havana,
guaranteed the performance of Havana’s obligations under
Lease No. 4210 and Lease No. 4536.
2
any chapter of the Bankruptcy Code, as amended,
or for the appointment of a receiver of any part
of the property of [Havana] be filed against
[Havana] . . . ; (c) such a petition be filed by
[Havana].
This shall be a continuing guaranty and
indemnity and, irrespective of the lack of any
notice to or consent of [the Sureties], their
obligations hereunder shall not be impared [sic]
in any manner whatsoever . . . .
Notice of your acceptance hereof, of default
and non-payment by [Havana] or any other parties,
of presentment, protest and demand, and of all
other matters of which [Restaurant Company or
Rochelle Holding Company] otherwise might be
entitled, is waived.[3]
Havana suffered from financial difficulties early in
its operation, and first defaulted on its obligations under
Lease No. 3084 in 1994. It continued to default on those
3
Although the actual agreements at issue bear the
title of “GUARANTY,” the circuit court concluded that The
Restaurant Company and Rochelle Holding Company were
accommodation sureties. The parties have not assigned
error to that ruling. See Rule 5:17(c); but see, The
Phoenix Ins. Co. v. Lester Bros., Inc., 203 Va. 802, 807,
127 S.E.2d 432, 436 (1962) (noting difference between
contract of a guarantor and that of a surety); Piedmont
Guano & Mfg. Co. v. Morris, 86 Va. 941, 944-45, 11 S.E.
883, 884 (1890) (same). Accordingly, this Court will treat
them as accommodation sureties, meaning they receive the
“benefit of the strictissimi juris rule.” Board of
Supervisors of Fairfax County v. Southern Cross Coal Co.,
238 Va. 91, 94, 380 S.E.2d 636, 638 (1989). Under that
rule, any change in the underlying obligation discharges a
surety’s obligation. Id. The rule, however, is limited by
the terms of the surety agreement itself. See American
Surety Co. v. Quincey, 125 Va. 1, 11, 99 S.E. 641, 644
(1919) (“whatever that contract is, the surety is bound by
it”).
3
obligations through at least 2002. In October 1996, Havana
filed for Chapter 11 bankruptcy protection. See 11 U.S.C.
§ 301 (1994); 11 U.S.C. §§ 1101 to 1174 (1994 & Supp. I
1996). The United States Bankruptcy Court for the Eastern
District of Virginia confirmed Havana’s Second Amended Plan
of Reorganization in September 1997. Regarding Lease No.
3084, Havana’s bankruptcy plan stated, “[t]he second
[United] lease . . . calls for monthly payments of
$1,111.85 for 60 months. The Debtor is current on this
lease and will assume it in its entirety.”
Because Havana continued to default on Lease No. 3084
after confirmation of its bankruptcy plan, United filed an
amended motion for judgment against Havana, the Sureties,
and Michael J. Ripp for the amounts due and owing under all
four leases, plus attorney’s fees and costs. As an
affirmative defense, the defendants asserted that the
applicable statute of limitations barred the action. The
case proceeded to a bench trial.
With regard to the statute of limitations issue before
us, the circuit court, in a letter opinion, concluded that
the Uniform Commercial Code governed the leases in
question, and that the applicable limitations period was
4
four years from the date of breach.4 See Code § 8.2A-
506(1). To decide when the applicable statute of
limitations commenced to run, the circuit court looked to
Havana’s Chapter 11 bankruptcy plan. The court concluded
that
the effect of Havana[]’s recommitment to the
United . . . leases under its Second Amended
Reorganization Agreement . . . is that the
[s]tatute of [l]imitations on each lease
specifically referred to in the Reorganization
Agreement began to run again as if a new lease
had been signed as of the date of that agreement.
The court viewed Havana’s “recommitment to the leases as a
complete recommitment including the guarantor’s
obligations.” Thus, the circuit court determined that the
four-year statute of limitations on Lease No. 3084
commenced to run at the time of the first default after
Havana’s Chapter 11 bankruptcy plan was confirmed on
September 3, 1997.
The circuit court then decided that, per the lease
agreements, a default occurred when Havana failed to timely
pay an installment on a lease and United then charged a
4
On brief, both parties discuss the statute of
limitations as being five years. Neither party, however,
assigned error to the circuit court’s ruling that the
appropriate statute of limitations is four years. Thus,
the four-year statute of limitations in Code § 8.2A-506(1)
is the law of the case. See Upper Occoquan Sewage Auth. v.
Blake Constr. Co., 266 Va. 582, 588, 587 S.E.2d 721, 724
(2003).
5
late fee. With regard to Lease No. 3084, the court
concluded that the first post-bankruptcy default happened
when United assessed a late fee on September 30, 1997 and
that, therefore, United’s filing of its motion for judgment
on September 14, 2001, was within the four-year statute of
limitations period.
After considering the evidence, the circuit court, as
to Lease No. 3084, entered judgment against the Sureties in
the amount of $88,769.20, plus attorney’s fees in the
amount of $17,753.84.5 This appeal followed.
II. ANALYSIS
On appeal, the Sureties assert, among other things,
that the circuit court erred in finding that United’s claim
against them under Lease No. 3084 was not barred by the
applicable statute of limitations.6 To decide that issue,
we must examine the nature of a Chapter 11 bankruptcy and
determine whether the assumption of an unexpired lease
5
The circuit court also entered judgment against the
other defendants in different amounts depending on their
respective liability under the various leases. In doing
so, the circuit court, however, held that the statute of
limitations had run with regard to any breach of Lease No.
4210. These rulings are not before us in this appeal.
Finally, the parties settled United’s claim under Lease No.
3083.
6
Because this issue is dispositive, we will not
address the remaining assignments of error.
6
creates a new obligation between the parties to the
original lease.
Relying on a leading bankruptcy law treatise, the
circuit court concluded the “[s]tatute of [l]imitations on
each lease specifically referred to in the Reorganization
Agreement began to run again as if a new lease had been
signed as of the date of that agreement.” In relevant
part, that treatise states:
If an executory contract or unexpired lease is
assumed after the case is commenced, the
assumption creates a new administrative
obligation of the estate. Thus, a breach of the
obligations after assumption gives rise to an
administrative claim of first priority. Further,
in a . . . Chapter 11 . . . case, an assumed
obligation is a postpetition obligation that is
not discharged, and which therefore continues to
be an obligation of the reorganized debtor.
2 William L. Norton, Jr., Norton Bankruptcy Law & Practice
2d § 39:27, at p. 39-87 (1997). The circuit court’s
decision turned on its view that assuming an unexpired
lease in a Chapter 11 bankruptcy plan was tantamount to
executing a new lease. We do not agree.
In its most basic sense, a Chapter 11 bankruptcy
proceeding allows a debtor to reorganize its business,
while continuing to operate.7 See In re Chateaugay Corp.,
7
The changes in the United States Bankruptcy Code that
became effective on October 17, 2005 have no bearing on the
issues in this appeal.
7
130 B.R. 162, 166 (S.D.N.Y. 1991); 7 Collier on Bankruptcy
¶ 1100.01 (Alan N. Resnick & Henry J. Sommer, eds., 15th
ed. rev. 2005). The Chapter 11 debtor-in-possession must
file a reorganization plan that enables it to continue its
business and to emerge from bankruptcy as a viable concern.
See Kane v. Johns-Manville Corp., 843 F.2d 636, 649 (2d
Cir. 1988); 7 Collier, supra, at ¶ 1100.9. As pertinent to
the case before us, a Chapter 11 reorganization plan may
“provide for the assumption, rejection, or assignment of
any executory contract or unexpired lease of the debtor not
previously rejected.” 11 U.S.C. § 1123(b)(2) (1994); see
also 11 U.S.C. § 365(a) (1994) (“the trustee, subject to
the court’s approval, may assume or reject any executory
contract or unexpired lease of the debtor”).
Explaining the purpose of a Chapter 11 bankruptcy
proceeding and the effect of assuming an executory contract
or unexpired lease, the United States Court of Appeals for
the Second Circuit stated:
Bankruptcy law also aims to avoid liquidation
altogether when that is possible. . . . It does
this by allowing a debtor to attempt to
reorganize rather than fold and by creating
incentives for creditors to continue to do
business with the debtor while reorganization
proceeds. The Code does this, at least in part,
by assuring these post-bankruptcy creditors that,
if the debtor fails to rehabilitate itself and
winds up in liquidation, they can move to the
front of the distributive line, ahead of the
8
debtor’s pre-bankruptcy creditors. Special
priority is therefore accorded to expenses
incurred under new contracts with the debtor, as
“administrative expenses” of the estate. The
same priority is given to expenses arising under
pre-existing contracts that the debtor “assumes”
– contracts whose benefits and burdens the debtor
decides, with the bankruptcy courts approval, are
worth retaining.
In re Klein Sleep Products, Inc., 78 F.3d 18, 20 (2d Cir.
1996).
“The rights created by assumption of the lease
constitute a post-petition administrative claim under
section 503(b)(1)(A) of the [United States Bankruptcy]
Code.” In re Greystone III Joint Venture, 995 F.2d 1274,
1281 (5th Cir. 1991). A claim is deemed administrative and
thus entitled to priority status upon distribution of the
bankruptcy estate “only if it arises out of a transaction
between the creditor and the bankrupt’s trustee or debtor-
in-possession, and only to the extent that the
consideration supporting the claimant’s right to payment
was both supplied to and beneficial to the debtor-in-
possession in the operation of the business.” Trustees of
the Amalgamated Ins. Fund v. McFarlin’s, Inc., 789 F.2d 98,
101 (2d Cir. 1986) (internal quotation marks and citation
omitted). In contrast, if a Chapter 11 debtor neither
assumes nor rejects an unexpired lease, the lease continues
in effect, but the lessor does not have a provable claim
9
against the bankruptcy estate. Greystone, 995 F.2d at
1281.
As noted, “a newly executed, post-petition contract
and an assumed, pre-petition contract receive similar
treatment” in a Chapter 11 bankruptcy proceeding. In re
The Lamparter Organization, Inc., 207 B.R. 48, 51 (E.D.N.Y.
1997). This is so because “each is the functional
equivalent of the other.” Id. Both create obligations
that are legally distinct from pre-petition obligations,
id., and claims arising from both are afforded priority
status in order to encourage third parties to conduct
business with the debtor-in-possession, thereby
facilitating its reorganization. Klein Sleep Products, 78
F.3d at 20.
But, the act of assuming an unexpired lease is merely
“an act of administration” by the debtor-in-possession.8 In
8
Some courts view a debtor-in-possession as a “new
juridical entity that is separate and apart from the
[d]ebtor which existed prior to bankruptcy proceedings.”
In re Multech, 47 B.R. at 750; see also, In re Mammoth
Mart, Inc., 536 F.2d 950, 954 (1st Cir. 1976); In re V.
Savino Oil & Heating Co., 99 B.R. 518, 524 (Bankr. E.D.N.Y.
1989); 7 Collier, supra, at ¶ 1101.01[3].
The Sureties have not argued that the entity assuming
Lease No. 3084, i.e., the debtor-in-possession, was an
entity legally distinct from the debtor Havana, who is the
party listed as the “Lessee” in Lease No. 3084 and as the
“Obligor” in the surety agreements at issue. But see, H.A.
Seinsheimer Co. v. Greenaway, 159 Va. 528, 533, 166 S.E.
539, 541 (1932) (burden of proof was on the creditor to
10
re Multech Corp., 47 B.R. 747, 750 (Bankr. N.D. Iowa 1985).
Contrary to the circuit court’s finding, assumption of
Lease No. 3084 by the debtor-in-possession was not
equivalent to the execution of a new lease by Havana.
Nothing about the terms of Lease No. 3084 changed; the
debtor-in-possession assumed the lease in its entirety.
The fact that an assumed, pre-petition unexpired lease is
treated the same as a new, post-petition lease, for
purposes of establishing the priority of payments from the
bankruptcy estate in the event the reorganization is
unsuccessful, did not transform the assumed Lease No. 3084
into a new lease with United.9
Nor do we agree with United’s argument that assuming
an unexpired lease in a Chapter 11 bankruptcy proceeding is
equivalent to a new promise to pay under Code § 8.01-
229(G). In pertinent part, the statute provides that
[i]f any person against whom a right of action
has accrued on any contract, . . . promises, by
prove that a claim fell within the scope of the guaranty
agreement and that the obligations incurred were for the
account covered by the guaranty).
9
Since the assumption of Lease No. 3084 did not create
a new obligation between Havana and United, the circuit
court’s finding that the Sureties’ agreements were
“continuing” is of no consequence. See Pascoe Steel Corp.
v. Shannon, 224 Va. 530, 534, 298 S.E.2d 97, 99 (1982) (“a
guaranty, unlimited as to time, but given in circumstances
evidencing the guarantor’s intent to cover a series of
transactions, will be construed as a continuing one”).
11
writing signed by him . . . , payment of money on
such contract, the person to whom the right has
accrued may maintain an action for the money so
promised, within such number of years after such
promise as it might be maintained if such promise
were the original cause of action.
Code § 8.01-229(G)(1). “[T]he effect of a ‘new promise in
writing’ is to begin the running of a new statute of
limitations permitting suit ‘within such number of years
after such promise as it might be maintained if such
promise were the original cause of action.’ ” Board of
Supervisors v. Sampson, 235 Va. 516, 521, 369 S.E.2d 178,
180 (1988) (citation omitted). As already explained
however, assumption of an unexpired lease in a Chapter 11
bankruptcy plan does nothing more than “determine[] the
status of the contracting creditor’s claim, namely whether
‘it is merely a pre-petition obligation of the debtor or is
entitled to priority as an expense of administration of the
estate.’ ” In re Univ. Med. Ctr., 973 F.2d 1065, 1078 (3d
Cir. 1992) (quoting Leasing Serv. Corp. v. First Tenn. Bank
Nat’l Ass’n, 826 F.2d 434, 437 (6th Cir. 1987)); accord In
re National Steel Corp., 316 B.R. 287, 304 (Bankr. N.D.
Ill. 2004). An assumption is not a new promise to pay
under Code § 8.01-229(G).10
10
The provisions in Code § 11-2.01 regarding a promise
to pay after bankruptcy apply only to a debt discharged in
bankruptcy.
12
Moreover, in order for an acknowledgement in writing
to operate as a new promise to pay, and commence the
running of a new statute of limitations period, it “must
not consist of equivocal, vague and indeterminate
expressions; but ought to contain an unqualified and direct
admission of a previous, subsisting debt, which the party
is liable for and willing to pay.” Nesbit v. Galleher, 174
Va. 143, 148, 5 S.E.2d 501, 503 (1939); see also Preston
County Coke Co. v. Preston County Light & Power Co., 119
S.E.2d 420, 430 (W. Va. 1961) (the writing “must be a clear
and definite acknowledgment of a precise sum, importing a
willingness and liability to pay”). Havana’s Chapter 11
bankruptcy plan merely stated that Lease No. 3084 would be
assumed in its entirety. The plan contained no language
about paying a “previous, subsisting debt.” Nesbit, 174
Va. at 148, 5 S.E. at 503. In fact, the plan stated that
Havana was current at that time with regard to its
obligations under Lease No. 3084. Indeed, if Havana had
been in default, the debtor-in-possession could not have
assumed Lease No. 3084 without, among other things, first
curing the default or providing adequate assurances that
the default would be promptly cured. See 11 U.S.C.
§ 365(b)(1)(A) (1994); In re PRK Enters., Inc., 235 B.R.
597, 600-01 (Bankr. E.D. Tex. 1999).
13
In concluding that the circuit court erred in finding
that the assumption of Lease No. 3084 was equivalent to
Havana’s having executed a new lease, we also find that the
circuit court erred by holding that the four-year statute
of limitations began to run at the time of Havana’s first
default after confirmation of its Chapter 11 bankruptcy
plan. Instead, the statute of limitations as to the
Sureties’ liability began to run in 1994 when Havana first
failed to fulfill its obligations under Lease No. 3084.
The surety agreements provided that all sums owing to
United by Havana would become immediately due and payable
if Havana defaulted in any of its obligations.11
The Sureties made a direct promise to United to
perform Havana’s obligations under Lease No. 3084 in the
event Havana failed to do so. See Courson v. Simpson, 251
Va. 315, 320, 468 S.E.2d 17, 20 (1996). “Where a surety’s
liability for the principal’s obligation has been
established, the surety is liable for the whole debt.”
Board of Supervisors of Fairfax County v. Southern Cross
Coal Corp., 238 Va. 91, 96, 380 S.E.2d 636, 639 (1989).
Upon default by Havana, United’s right to proceed against
11
The surety agreements also stated that all sums
would become due and owing upon Havana’s filing a petition
under any chapter of the United States Bankruptcy Code.
14
the Sureties existed independently of its right to proceed
against Havana. See First Virginia Bank-Colonial v. Baker,
225 Va. 72, 77, 301 S.E.2d 8, 11 (1983) (citing 74 Am. Jur.
2d Suretyship § 135 (1974)). That right accrued upon
Havana’s default in 1994.12 Since United did not file this
action until September 2001, the four-year statute of
limitations barred the action.13
The only remaining question is whether Havana’s
Chapter 11 bankruptcy tolled the running of the applicable
statute of limitations. Filing for bankruptcy protection
automatically stays any action against the debtor. 11
U.S.C. § 362(a) (1994). It is well-established that the
automatic stay does not extend to actions brought against a
surety. See Winters v. George Mason Bank, 94 F.3d 130, 133
(4th Cir. 1996) (“[i]t is well settled that the automatic
stay does not apply to non-bankrupt co-debtors, . . . nor
12
We find no merit in United’s argument that the
Sureties failed to prove when the statute of limitations
commenced to run because they did not establish when United
called upon them to make payment. Unlike the guaranty
agreement at issue in McDonald v. National Enterprises,
Inc., 262 Va. 184, 192, 547 S.E.2d 204, 209 (2001), the
surety agreements presently before us did not contain terms
requiring United to demand payment from the Sureties.
13
The statute of limitations would also bar the action
if the four-year period did not commence to run until
Havana filed its Chapter 11 bankruptcy petition in 1996
since that event also triggered the Sureties’ obligations
under the terms of their agreements.
15
. . . prevent actions against guarantors of loans)
(citations omitted); In re Lockard, 884 F.2d 1171, 1179
(9th Cir. 1989) (refused to extend the automatic stay
noting “a surety has obligations that are ‘independent’ and
primary, not derivative of those of the debtor”); see also
Cumberland Metals, Inc. v. Kentucky Insurance Guaranty
Assoc., 801 S.W.2d 339, 340 (Ky. Ct. App. 1990) (“a stay
granted to [a] debtor does not extend to the surety”);
Seaboard Surety Co. v. Board of Chosen Freeholders of the
County of Warren, 537 A.2d 310, 313 (N.J. Super. Ct. App.
Div. 1988) (“[t]he law is well settled that the automatic
stay provided for by the bankruptcy law extends only to
claims against the debtor himself and not against others,
including sureties, whose liability to the creditor for the
obligations of the debtor has an independent basis”).
Because the automatic stay did not bar United’s independent
right to proceed against the Sureties, Havana’s filing for
bankruptcy protection did not toll the statute of
limitations with regard to United’s claim against the
Sureties. See Fountain Sand and Gravel Co. v. Chilton
Constr. Co., 578 P.2d 664, 665 (Colo. Ct. App. 1978)
(“principal’s bankruptcy does not toll the statute of
limitations on an action against the surety”); United
States Fire Ins. Co. v. State, 843 S.W.2d 283, 286 (Tex.
16
App. 1992)(debtor’s bankruptcy had no effect on cause of
action against surety).
In summary, we conclude that the circuit court erred
in finding that the assumption of Lease No. 3084 in
Havana’s Chapter 11 bankruptcy plan was equivalent to
Havana’s having executed a new lease with United. Thus,
the four-year statute of limitations with regard to the
Sureties’ liability commenced to run in 1994 when Havana
initially defaulted on its obligations under Lease No.
3084. Havana’s bankruptcy proceeding did not toll the
running of the statute of limitations. Therefore, the
four-year statute of limitations barred the present action
filed in September 2001.
III. CONCLUSION
For those reasons, we will reverse the circuit court’s
judgment against the Sureties under Lease No. 3084 and
enter final judgment in favor of the Sureties.
Reversed and final judgment.
17