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NOT FOR PUBLICATION

UNITED STATES BANKRUPTCY APPELLATE PANEL

OF THE NINTH CIRCUIT

In re: ) BAP No. CC-13-1563-KiTaD

)

GENTILE FAMILY INDUSTRIES, ) Bk. No. 13-16402-TA

)

Debtor. )

 )

)

DIATOM, LLC, )

)

Appellant, ) 

)

v. ) M E M O R A N D U M1

)

COMMITTEE OF CREDITORS HOLDING)

UNSECURED CLAIMS; GENTILE )

FAMILY INDUSTRIES, )

)

Appellees. )

______________________________)

Argued and Submitted on June 26, 2014, 

at Pasadena, California

Filed - August 19, 2014

Appeal from the United States Bankruptcy Court

for the Central District of California

Honorable Theodor C. Albert, Bankruptcy Judge, Presiding

 

Appearances: David Max Gardner, Esq. of Young Wooldrige LLP

argued for appellant, Diatom, LLC; Jeffrey Wayne

Broker, Esq. of Broker & Associates PC argued for

appellee, Gentile Family Industries; Nanette D.

Sanders, Esq. of Ringstad & Sanders LLP argued for

appellee, Committee of Creditors Holding Unsecured

Claims.

 

Before: KIRSCHER, TAYLOR and DUNN, Bankruptcy Judges.

FILED

AUG 19 2014

SUSAN M. SPRAUL, CLERK

U.S. BKCY. APP. PANEL

OF THE NINTH CIRCUIT

1 This disposition is not appropriate for publication. 

Although it may be cited for whatever persuasive value it may have

(see Fed. R. App. P. 32.1), it has no precedential value. See 9th

Cir. BAP Rule 8013-1.
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Creditor Diatom, LLC ("Diatom") appeals an order approving

the motion of chapter 112 debtor Gentile Family Industries ("GFI")

to assume an unexpired nonresidential real property lease. We

AFFIRM.3

I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

A. Events prior to GFI's bankruptcy

GFI's principal business is an open pit diatomaceous earth

mining operation on land leased from Diatom. Steven Gentile

("Gentile") is the President of GFI. GFI pays royalties to Diatom

based upon the tonnage of diatomaceous earth mined. Virtually all

of GFI's business comes from the Diatom mining operation. Diatom

is comprised of three members — Mr. and Mrs. Cooper and their son

David Cooper. 

Although GFI had been mining on the Diatom property since

2001, the parties did not have a written lease until 2006. On

January 12, 2006, GFI and Diatom executed a Land Use Agreement for

Mining Purposes (the "Cooper Lease"). The Cooper Lease had an

initial term through December 31, 2010, with the option for

additional five year terms: 

Term. The initial term of the Agreement shall be from

the date of this Agreement to and including December 31,

2010 . . . . The Term shall be for five (5) years with

the option for additional five (5) year terms as long as

all conditions of operation meet the "Owner's" approval

and both "GFI" and "Owner" agrees [sic] to future use of

2 Unless specified otherwise, all chapter, code and rule

references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and

the Federal Rules of Bankruptcy Procedure, Rules 1001-9037.

3 GFI filed a motion to supplement the record, which includes

several notices of cure payments in connection with its approved

motion to assume. Because these exhibits have no bearing on our

decision in this appeal, we DENY the motion.

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the same surface areas as currently agreed upon, unless

sooner surrendered or otherwise terminated.

The Cooper Lease expired on December 31, 2010. Nothing was

expressly communicated between the parties about exercising the

option for another five-year term, but they proceeded with

business as usual for the next thirty months until GFI's

bankruptcy filing in July 2013. Gentile testified that at all

times subsequent to December 31, 2010, he believed the Cooper

Lease was in its second five-year term.

In or around 2012, GFI fell behind on its royalty payments to

Diatom. On July 13, 2013, Diatom served a 30-day notice to cure

over $140,000 in royalty arrearages and other various defaults

under the Cooper Lease (the "Default Notice"). The Default Notice

reminded GFI of its unfulfilled obligations for biannual increases

in the royalty rates according to the terms of the Cooper Lease,

noting that the lease was "now in its seventh (7) year of life[.]"

B. Postpetition events 

1. GFI's motion to assume the Cooper Lease 

In response to the Default Notice, GFI filed a chapter 11

bankruptcy case on July 29, 2013, and timely moved to assume the

Cooper Lease under § 365(b)(1)("Motion to Assume"). GFI argued

the Cooper Lease was not expired and, thus, was assumable based on

the parties' conduct, Diatom's admission in the Default Notice

that the Cooper Lease was in its "seventh (7) year of life" and

because no written communication existed to suggest the Cooper

Lease was anything other than in its first renewal term. GFI

argued that if it was not allowed to assume the lease, it would be

forced to close its business and cease operations almost

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immediately, leaving little or no recovery for unsecured

creditors. The Official Committee of Creditors Holding Unsecured

Claims joined in GFI's motion, contending it would help promote a

successful reorganization and was in the best interest of

creditors. 

Diatom opposed the Motion to Assume on two grounds: (1) GFI

was improperly using the assumption process under § 365 to get a

declaratory ruling that the Cooper Lease's term was something

other than month-to-month;4 and (2) the Cooper Lease was not in

the middle of a second five-year term as contended by GFI. Diatom

argued that under CAL. CIV. CODE § 1945, GFI became a month-to-month

tenant effective January 1, 2011, because it had not exercised the

option to extend the Cooper Lease by an additional five-year term. 

Relying on the paragraph entitled "Notices," Diatom argued that

because GFI did not communicate a renewal in writing, the Cooper

Lease was not renewed in January 2011: 

Notices. All notices and other communications to other

party shall be given in writing and shall be sufficiently

given if (i) delivered in person, (ii) sent by electronic

communication, with confirmation sent by registered or

certified mail, return receipt requested, or (iii) sent

by registered or certified mail, return receipt requested

. . . . 

Diatom disputed GFI's assertion that the "seventh (7) year of

life" comment Mrs. Cooper made in the Default Notice evidenced the

parties' agreement the Cooper Lease was in a second five-year

term. Her description simply identified that it had been seven

years since the Cooper Lease was executed.

4 Diatom's objection to the alleged deficient procedural

process was stated only in the "Introduction" section of its

opposing brief and was not supported by any further argument or

authority. 

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Diatom conceded California case law provides that a tenant's

continued possession of the premises may be a valid exercise of an

option to renew, citing ADV Corp. v. Wikman, 178 Cal.App.3d 61

(1986), but argued that ADV is distinguishable because the option

to renew there was not required to be in writing. Diatom also

argued that GFI, unlike the tenant in ADV, did not engage in any

conduct prior to the expiration of the original term to indicate

that it intended to extend the Cooper Lease for another five

years. Attached to Diatom's opposition was a declaration from

David Cooper and copies of cases and treatises Diatom argued

supported its position that the Cooper Lease was on a month-tomonth basis.

In reply, GFI argued that the Cooper Lease was silent on the

mechanics by which the option to extend for additional five-year

terms could be effected and nowhere in the "Term" section, which

is the only place where the option is discussed, was there a

requirement that exercise of the option be in writing. GFI argued

that California and Ninth Circuit law was clear: when no writing

is required under the terms of the lease to interpret a renewal,

the conduct of the parties establishes it. Thus, GFI's continued

possession and the actions of the parties conclusively established

the option had been exercised to extend the Cooper Lease for a

second five-year term, which was in place for thirty months prior

to Diatom’s issuance of Default Notice. 

2. The bankruptcy court's ruling on the Motion to Assume 

At the hearing on the Motion to Assume, counsel for Diatom

conceded the Cooper Lease was executory and could be assumed by

GFI. However, Diatom objected to GFI's ability to seek what was

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essentially a declaratory ruling as to the term of the Cooper

Lease. Notwithstanding that objection, counsel proceeded to argue

the Cooper Lease was only on a month-to-month term due to GFI's

failure to communicate in writing that it was exercising the

option to extend the lease for another five-year term. The

bankruptcy court agreed that a debtor seeking to assume a lease

cannot change or amend the lease's term. Nonetheless, it

disagreed with counsel's contention that GFI had to provide

notice, either in writing or otherwise, to extend the Cooper

Lease. Counsel for Diatom conceded that the "Term" section was

silent as to whether notice had to be given in order to extend it. 

After hearing further argument from Diatom that the Cooper

Lease was month-to-month, the bankruptcy court stated:

I disagree. I think that continued occupation,

continuing tendering of rent is probably enough to get

them around this argument you have, which just lapsed

into a month to month. Even your own client didn't treat

this as a month to month because they've gone ahead and

given two years after the fact a written notice, so even

they don't think it's a month to month. I don't think

that cuts much ice.

Hr'g Tr. (Nov. 6, 2013) 12:20-13:2.

The bankruptcy court entered an order approving the Motion to

Assume on November 14, 2013. In addition to the required findings

under § 365(b)(1), the court determined that the "Cooper Lease was

extended by the conduct of the parties into its first five (5)

year option term commencing as of December 30, 2010[.]" Diatom

timely appealed.

II. JURISDICTION

The bankruptcy court had jurisdiction under 28 U.S.C. § 1334

and § 157(b)(2)(A). We have jurisdiction under 28 U.S.C. § 158.

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III. ISSUE

Did the bankruptcy court err when it determined in the

context of the Motion to Assume the disputed issue of whether the

Cooper Lease had been extended for another five years or whether

its term was month-to-month?

IV. STANDARD OF REVIEW

Whether the bankruptcy court's procedures comport with due

process is reviewed de novo. Price v. Lehtinen (In re Lehtinen),

564 F.3d 1052, 1058 (9th Cir. 2009); Garner v. Shier

(In re Garner), 246 B.R. 617, 619 (9th Cir. BAP 2000).

V. DISCUSSION

The bankruptcy court's decision to determine the term of the 

Cooper Lease in a contested matter rather than requiring an

adversary or some other proceeding was harmless error.

Diatom contends the bankruptcy court erred by deciding the

issue of the Cooper Lease's term in the context of the Motion to

Assume, which Diatom contends is a summary proceeding and limited

in nature. Diatom argues the bankruptcy court exceeded the scope

of its authority under § 365 when it decided this disputed

contract issue, and it requests on appeal the "right to prove,

through the appropriate legal procedure, that the lease term is

month-to-month under clear California law." Diatom suggests the

issue of the contract term would be best resolved in an unlawful

detainer action or an action for declaratory relief. GFI argues

that it was appropriate for the bankruptcy court to inquire into

whether the Cooper Lease was unexpired as part of its ruling on

the Motion to Assume. 

Whether to assume or reject an executory contract or

unexpired lease is left to the business judgment of the trustee or

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debtor in possession. Official Creditors Comm. v. X10 Wireless

Tech., Inc. (In re X10 Wireless Tech., Inc.), 2005 WL 6960205, at

*3 (9th Cir. BAP Apr. 5, 2005)(citing Durkin v. Benedor Corp.

(In re G.I. Indus., Inc.), 204 F.3d 1276, 1282 (9th Cir. 2000)). 

It is undisputed that only an executory contract or unexpired

lease of the debtor existing at the time of petition is capable of

being assumed; the issue whether the subject contract or lease has

terminated prepetition is determined under state law. Vanderpark

Props., Inc. v. Buchbinder (In re Windmill Farms, Inc.), 841 F.2d

1467, 1469 (9th Cir. 1987); In re Kong, 162 B.R. 86, 91 (Bankr.

E.D.N.Y. 1993)(if the contract or lease has expired by its own

terms or has been terminated prior to the petition date then

nothing exists for debtor to assume or reject); § 365(a). The

bankruptcy court clearly has the authority to determine this

threshold issue. See In re Windmill Farms, Inc., 841 F.2d at

1472; In re Kong, 162 B.R. at 91 (before a debtor can seek relief

under § 365(a), it must be established that an executory contract

or unexpired lease exists at the time of the filing)(citing

2 COLLIER ON BANKRUPTCY ¶ 365.02 (Lawrence P. King et al., eds. 15th

ed. 1992)). 

The question of whether the Cooper Lease was "unexpired" was

not disputed. Diatom repeatedly conceded the Cooper Lease was

unexpired at the time GFI filed for bankruptcy and that it was

capable of being assumed. What Diatom disputes is whether the

bankruptcy court could determine the disputed lease term in the

context of the Motion to Assume.

Diatom relies on Orion Pictures Corp. v. Showtime Networks,

Inc. (In re Orion Pictures Corp.), 4 F.3d 1095, 1098 (2d Cir.

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1993), to support its position that the bankruptcy court could not

decide this issue in the context of the Motion to Assume. In

Orion, the debtor entered into a prepetition contract with

Showtime. Showtime contended Orion breached the contract and

could not assume it. Orion moved to assume the contract under 

§ 365 and simultaneously filed an adversary proceeding against

Showtime claiming anticipatory breach. The bankruptcy court tried

the breach issue in connection with the assumption motion. 

Determining that Orion had not breached, the court authorized the

assumption and dismissed the related adversary proceeding as moot. 

The district court affirmed. 

In reversing, the Second Circuit held § 365 did not authorize

bankruptcy courts to resolve questions involving the validity of

contracts in the context of assumption motions. "[I]t was error

for the bankruptcy court to decide a disputed factual issue

between the parties to a contract in the context of determining

whether the debtor or trustee should be permitted to assume that

contract." Id. at 1098. "At heart, a motion to assume should be

considered a summary proceeding, intended to efficiently review

the trustee's or debtor's decision to adhere to or reject a

particular contract in the course of the swift administration of

the bankruptcy estate. It is not the time or place for prolonged

discovery or a lengthy trial with disputed issues." Id. at

1098-99. 

Although not cited by the parties, the Ninth Circuit adopted

the reasoning of Orion in In re G.I. Indus., Inc., 204 F.3d at

1282. There, a creditor had sued debtor for breach of contract in

state court prepetition. Shortly thereafter, debtor filed a

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chapter 11 bankruptcy case and attempted to remove the action to

the bankruptcy court. After that failed, the trustee moved to

reject the parties' contract. The bankruptcy court agreed the

contract was burdensome; the rejection was within the sound

business judgment of the trustee. Based on the rejection, the

creditor filed a proof of claim for damages under § 365(g). The

trustee objected to the proof of claim. As a result, the

bankruptcy court held a five-day trial inquiring into the validity

of the contract. The court ultimately disallowed the creditor's

claim, finding that the contract was unenforceable due to a lack

of mutual intent between the parties and a lack of consideration. 

The district court affirmed. Id. at 1279-80.

On appeal, the creditor contended the trustee's rejection of

the contract conclusively established a statutory breach of

contract that precluded the bankruptcy court from inquiring into

the validity of the underlying contract. Id. at 1280. The Ninth

Circuit disagreed, holding the bankruptcy court could properly 

examine the validity of a rejected contract during the claims

process based on the plain language of § 502(b)(1). However,

relying on Orion, it went on to hold:

Based on the nature of a motion to reject and its

complementary proceedings, it is inappropriate for the

court to resolve questions involving the validity of a

contract at the time of rejection. As the Second Circuit

noted in Orion Pictures Corp. v. Showtime Networks, Inc.

(In re Orion Pictures Corp.), 4 F.3d 1095 (2d Cir. 1993),

"permitting a bankruptcy court to rule conclusively on a

decisive issue of breach of contract would render the use

of ‘business judgment' . . . unnecessary." Id. at 1099. 

Orion correctly recognizes that adjudicating the validity

of a contract at the time of rejection would turn a

summary proceeding into a full trial on the merits, a

result that would be inconsistent with the procedures

found in the Bankruptcy Code. Instead, our approach

gives effect to the plain language of the Bankruptcy Code

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and allows a bankruptcy judge to postpone consideration

of the validity of a contract until a full adversary

proceeding can take place. This approach better conforms

with the structure of the code.

Id. at 1282. In other words, the validity of a contract, if

disputed, cannot be determined in the context of a motion to

assume or reject. An adversary proceeding is required. 

Whether a determination as to the "term" of an unexpired

lease is a determination on the "validity" of a contract for

purposes of § 365 is not clear. The Ninth Circuit has not defined

exactly what falls into the "validity" category. Certainly,

Diatom and GFI never questioned the Cooper Lease's "validity." 

However, taking a broad view of G.I. Indus., Inc., it may be that

an adversary proceeding was required for the bankruptcy court to

determine the term of the Cooper Lease. We need not decide that

issue, however, because for all practical purposes an adversary

proceeding was held in this case.

Diatom characterized the relief GFI sought as to the Cooper

Lease's term as an action for declaratory relief. Generally, an

adversary proceeding is required for a declaratory judgment under

Rule 7001(9).

It is error to circumvent the requirement of an

adversary proceeding by using a 'contested matter'

motion under Rule 9014.[5] Such an error may

nevertheless be harmless when the record of the

procedurally incorrect 'contested matter' is developed

to a sufficient degree that the record of an adversary

proceeding likely would not have been materially

different.

Ruvacalba v. Munoz (In re Munoz), 287 B.R. 546, 551 (9th Cir. BAP

5 Under Rule 6006, a proceeding to assume, reject or assign

an executory contract or unexpired lease is governed by Rule 9014. 

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2002); Trust Corp. of Mont., Inc. v. Patterson (In re Copper King

Inn, Inc.), 918 F.2d 1404, 1407 (9th Cir. 1990)(where the record

shows the parties received adequate notice concerning the nature

of the issues raised in a contested motion proceeding, extensive

hearings occurred, briefing was submitted and the parties were

given ample time to air their position; for all practical purposes

an adversary proceeding was held). See also Korneff v. Downey

Reg'l Med. Ctr. Hosp., Inc. (In re Downey Reg'l Med. Ctr. Hosp.,

Inc.), 441 B.R. 120, 127 (9th Cir. BAP 2010) (bankruptcy court's

decision not to require an adversary proceeding is subject to a

harmless error analysis). "In such circumstances, the error does

not affect the substantial rights of the parties and is not

inconsistent with substantial justice." In re Munoz, 287 B.R. at

551. See, e.g., 28 U.S.C. § 2111; Rule 9005; In re Copper King

Inn, Inc., 918 F.2d at 1406-07; Laskin v. First Nat'l Bank

(In re Laskin), 222 B.R. 872, 874 (9th Cir. BAP 1998); United

States v. Valley Nat'l Bank (In re Decker), 199 B.R. 684, 689–90

(9th Cir. BAP 1996). 

Even if the bankruptcy court possibly erred in not requiring

an adversary proceeding to determine the Cooper Lease's term, we

conclude that such error was harmless. GFI was clear in its

Motion to Assume what relief it was seeking and on what basis; it

contended the Cooper Lease was in the middle of another five-year

term. Diatom had the opportunity to comprehensively brief the

issues and did so by filing its opposition, which included a

declaration from David Cooper and copies of cases supporting its

position that the term was month-to-month. Notably, while Diatom

objected to the bankruptcy court determining the disputed term

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issue in the context of the Motion to Assume, it has never fully

briefed its objection until now. Plus, Diatom never requested a

continuance of the hearing on the Motion to Assume. The hearing

was held as scheduled; the parties had ample time to air their

positions. After considering the parties' evidence and arguments,

the bankruptcy court determined, as a matter of law, that the

Cooper Lease term had been extended another five years. 

On this record, we have difficultly understanding how Diatom

was procedurally disadvantaged by the bankruptcy court's approach. 

We fail to see, particularly since the material facts were few and

undisputed and the issue before the court was purely one of law,

how an adversary (or some other) proceeding would have produced a

materially different result. Diatom did not convince us otherwise

in its appeal brief or at oral argument. Absent a credible

argument or specific examples from Diatom showing it suffered some

procedural disadvantage as a result of the bankruptcy court's

procedure, the court allowing the matter to proceed as a contested

motion rather than an adversary proceeding is not a sufficient

reason to disturb the assumption order. Had the bankruptcy court

determined the lease term issue in Diatom's favor, this matter

would likely not be before us. 

Accordingly, even if the bankruptcy court erred in not

requiring an adversary proceeding to determine the term of the

Cooper Lease, such error did not affect the substantial rights of

the parties, is not inconsistent with substantial justice and was

therefore harmless. In re Munoz, 287 B.R. at 551.6

6 Diatom does not contest the bankruptcy court's

continue...

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VI. CONCLUSION

For the foregoing reasons, we AFFIRM. 

6...continue

determination that the Cooper Lease had been extended for an

additional five-year term, only that it erred in making that

determination in the context of the Motion to Assume. Therefore,

we do not address the merits of the bankruptcy court's decision. 

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