if, under federal law, the Ground Lease itself was not terminated
upon rejection, the Ground Lease itself was terminated under New
Mexico law when, upon rejection, Kmart was required to forfeit any

Ground Lease. Therefore, even

li

possessory interest it had under thd

the Ground Lease as being

without the Bankruptcy Court 4
ease ceased to exist as of

terminated, rights under the G
December 6, 2002 and the Rent C ment Date never occurred.
Iv. OTHER CONTENTIONS 14

|

Sierra alternatively argues! at it was improper to permit
rejection of the Ground Lease while allowing the Original Lease to
be assumed. This is based on the contention that there is only one
integrated lease and that, under § 365, it is improper to permit
selective rejection and assumption of provisions of a lease. As
was discussed above, the Ground Lease and Original Lease were not
integrated, but remained separate and distinct leases under the
terms of the Ground Lease. Since the premise for Sierra's argument
(the existence of a single, integrated lease) is incorrect, this
argument fails. It is therefore unnecessary to consider whether
the "separability" clause of the Ground Lease (§ 34) would have

allowed for rejection of the Ground Lease and acceptance of the

Original Lease. See In re Plitt Amusement Co. of Washington, Inc.,

233 B.R. 837, 845-46 (Bankr. C.D. Cal. 1999); In re Integrated

Health Services, Inc., 2000 WL 33712484 *3-4 (Bankr. D. Del. July

7, 2000).
Sierra's last contention is that the Bankruptcy Court

should have held an evidentiary hearing and considered extrinsic

- 19 -


330 F.3d 36, 42 {ist Cir. 2003); In re Miller, 282 F.3d 874, 878
(6th Cir. 2002). Appropriate rents and other obligations accruing
between the filing of the petition and the date of rejection become
administrative expenses. See 11 U.S.C. § 365(d) (3); In re Handy
Andy_ Home Improvement Centers, Inc., 144 F.3d 1125 (7th Cir. 1998);
In_re Trans World Airlines, Inc., 145 F.3d 124, 136-37 (3d Cir.

1998); In re CCI Wireless, LLC, 297 B.R. 133, 141-42 (D. Colo.

2003); In re Twigla ‘ashio: c., 198 B.R. 199, 200-01 (W.D.
Tex. 1996).

The two rules just recited cover the time up until the
actual date of rejection. The issue in the present case is what
happens subsequent to rejection. Under the Bankruptcy Court's
order of October 30, 2002, Sierra was to "be entitled to immediate
possession of the premises as of the Rejection Date, subject to
applicable state law.” Docket item 7291 q7 1. That order
essentially terminated the Ground Lease effective December 6, 2002,
leaving Sierra with an unsecured claim for damages based on breach
and a priority claim for any appropriate administrative expenses.
If the Bankruptcy Court's order was proper, no Rent Commencement

Date occurred because the Ground Lease had already ended before

December 14, 2002 arrived. See Mayfield Smithson Enterprises v.

Com-Qui. Inc., 120 N.M. 9, 896 P.2d 1156, 1162-63 (N.M. 1995)
(where bankruptcy court approves debtor-lessee's rejection of lease
and orders that debtor surrender property to the lessor, the

leasehold and related rights are extinguished).

-13-


6. ai 4 © Vv: Commo
Areas.
ek ok ok
(g) . . . the parties acknowledge that Lessee
will continue to operate the existing Kmart store
{Big K] in the Shopping Center during construction
of the Kmart Building for as long as practicable,
to be determined by the Lessee in its reasonable
discretion, and the demolition of the existing
Kmart store shall occur thereafter at the time
deemed appropriate by Lessee, in its sole
discretion. ...
ek ok
41. Governing Law. This Lease shall be
governed by and interpreted under the laws of the
state in which the Premises are located.

42. Entire Agreement. This Lease, and the
Exhibits attached hereto and forming a part

hereof, set forth all understandings between
Lessor and Lessee concerning the Premises and
there are no covenants, promises, agreements,
conditions, provisions or understandings, either
oral or written, between them other than are
herein set forth.

ek Ok

45. Existing Lease. The parties acknowledge
the existence of the lease in effect dated June

20, 1977, as amended by First Amendment of Lease
dated April 4, 1979 (as amended, the "Original
Lease"), whereby Lessor currently leases to Lessee
the existing Kmart store in the Shopping Center
upon 14.3 acres of land. Upon the occurrence of
the Rent Commencement Date as provided herein, and
only upon the occurrence of the Rent Commencement
Date, the Original Lease shall be terminated as if
the Rent Commencement Date was the date set forth
in the Original Lease for the expiration of the
term thereof.

Section 7 of the Ground Lease sets forth the length of the
lease. The initial length of the Ground Lease is broken down into
three phases. The “Preliminary Term" was to run from the signing
of the Ground Lease until the Rent Commencement Date. The "Interim

Term" was to run from the Rent Commencement Date until the last day

of the month in which the Rent Commencement Date fell. The


evidence in determining whether the Original Lease and Ground Lease
remained separate contracts. Under New Mexico law, extrinsic
evidence is generally not considered if the contract language is

unambiguous when construed. in light of the surrounding

circumstances. See Strata Production Co. v. Mercury Exploration
Co., 121 N.M. 622, 916 P.2d 822, 830 {(N.M. 1996); Medina v.

Sunstate Realty, Inc., 119 N.M. 136, 889 P.2d 171, 173 (N.M. 1995).

As discussed above, sections 42 and 45 provide unambiguously that
the Original Lease remains separate and in force until terminated
in accordance with the provisions of § 45. Additionally, Sierra
never suggested to the Bankruptcy Court that there was relevant
disputed extrinsic evidence. Even on appeal, it was not until its
reply that Sierra first identified what this disputed evidence
might be.’° Alternatively, Sierra has waived any opportunity to
contend that the Ground Lease must be construed in light of

extrinsic evidence not considered by the Bankruptcy Court. See

Unelko Corp, v. Prestone Products Corp., 116 F.3d 237, 239 (7th
Cir. 1997); Carmichael _v. The Payment Center, Inc., 336 F.3d 636,

642 (7th Cir. 2003).
Vv. CONCLUSION

For the foregoing reasons, the Bankruptcy Court acted
properly in determining that the Original Lease remained in force.
With the Original Lease still in force, no basis exists for

evicting Kmart from the Big K premises. Therefore, it was also

Tt is not even clear from Sierra's summary description
that there is extrinsic evidence that could affect the
construction of the Ground Lease.

- 20 -


Bankruptcy Court depending on the particular facts and
circumstances of the lease.®
: Here, the Bankruptcy Court acted properly in treating the
rejection as a termination of the lease, whether under federal law
or state law. Kmart never constructed or opened the new Super K
and, because of rejection, will not do so following reorganization.
Sierra had already removed other tenants and demolished the
existing buildings, but such expenses will be appropriately
compensated through its prepetition claim for damages arising from
the breach, as well as through Construction Rent that was paid
prior to Kmart's bankruptcy petition and Construction Rent paid as
an administrative expense until the effective date of the
rejection. There is no contention that any third-party mortgagors
or other lienholders were adversely affected by treating the
rejection as a_ termination. Under these circumstances,
surrendering the premises was essentially a complete termination of
the parties’ relationship under the Ground Lease. Therefore, the
Bankruptcy Court did not abuse any discretion it had to treat the
rejection and Kmart's surrender of any right to the property as a
termination of the lease under § 365.
Moreover, even if the Bankruptcy Court had treated the

rejection as a basis for requiring surrender and terminating the

®tn accordance with § 365(d) (4), surrender of the
property would be mandatory where the rejection occurs through
failure to make a timely election. The present case does not
present the issue of whether there would be any appropriate
exceptions to the mandate of that provision. In the present
case, Kmart affirmatively elected to reject the Ground Lease.

-17 -


The Original Lease is not an exhibit to the Ground Lease. However,
the Original Lease pertains to the portion of the Ground Lease
Premises that overlaps the land covered by the Original Lease.
This is not an inconsistency because § 45 of the Ground Lease
expressly acknowledges the continued existence of the Original
Lease, and the integration clause does not state that prior
agreements are superseded or amended. Under the plain language of
the Ground Lease, the Original Lease continues to exist until it is
terminated in accordance with § 45, Since the Original Lease
itself, including its terms, is not actually incorporated in, made
a part of, or attached as an exhibit to the Ground Lease, under the
plain language of § 42 of the Ground Lease, the Original Lease
remains a separately existing contract until terminated in
accordance with § 45.

Under New Mexico law,‘ the principle of substitution
(merger) applies when there are two contracts on the same subject
matter. Under that principle, a presumption arises that the prior
contract is included in the later contract and, where there is an
inconsistency between the two contracts, the later contract will
control. Richards v. Allianz Life Insurance Co. of North America,
133 N.M. 229, 62 P.3d 320, 324 (N.M. Ct. App.), cert. denied, 133
N.M. 30, 59 P.3d 1262 (N.M. 2002). Regardless of the presumption,

however, the language of the contracts still must be considered,

‘The Original Lease does not contain a choice of law
provision. However, the parties have assumed New Mexico law
applies. This is appropriate since the subject matter of the
lease is real property located in New Mexico.


Payments due prior to the Rental Commencement Date apparently were
less than what would be due under the Ground Lease, but would still
be something more than $40,667.00 per month.

Section 30 of the Ground Lease is entitled "Conditions
Subsequent." These were all conditions that had to be met by
Sierra, including such things as obtaining necessary permits and
zoning, environmental and topography requirements, preparing curb
cuts for construction vehicles, and having tenants move out of the
existing buildings. Most of these conditions had deadlines of
November 30, 2001 and Sierra represents in its brief that all the
conditions of § 30 were timely satisfied. Had it not satisfied the
conditions, however, Kmart could have terminated the Ground Lease
or, for one condition, the Rent Commencement Date could have been
extended. See First Amendment to Ground Lease {@ 1-2.

On January 22, 2002, Kmart filed its Chapter 11 bankruptcy
petition. Kmart continued to operate its business as the debtor-
in-possession. Under 11 U.S.C. § 365, Kmart had the option of
assuming or rejecting unexpired leases. Id. § 365(a). Kmart was
to make its assumption/rejection elections as to leases within 60
days after filing the petition or within such additional time as
might be permitted by the bankruptcy court. Id. § 365(d) (4). Upon
the motion of Kmart and the opposition of Sierra and other parties,
the bankruptcy court granted an extension of this deadline until
March 31, 2003 for certain leases (including the Ground Lease) and
until July 31, 2003 or confirmation for other leases (including the

Original Lease).


"Primary Term" was to run for 25 years from the first day of the
month following the Rent Commencement Date. Section 7 also
provided for "Extended Terms," permitting Kmart to renew for up to
ten additional five-year terms and a "Supplemental Term" permitting
Kmart to make January 31 the last date of the final term. Section
7 also contains the following provision:

(e) Confirmation of Rent Commencement Date.

Within thirty (30) days after a request by either

party after the Rent Commencement Date has been

determined, Lessor and Lessee shall execute,

acknowledge and deliver to each other duplicate
originals of an agreement setting forth the Rent

Commencement Date, the date of commencement and

expiration of the Primary Term of this Lease and

the date of commencement of the first Extended

Term in the event the option of Lessee to extend

is thereafter exercised.

Section 8 contains the rent provisions. No "Basic Rent"
had to be paid during the Preliminary Term. Once the Primary Term
begins, Basic Rent was to be $53,437.50 per month for the first ten
years. During the Interim Term, a daily amount was to be paid that
would have been equal to the monthly rent during the Primary Term.
Although no Basic Rent was to be paid during the Preliminary Term,
during that time period Kmart was to pay “Construction Rent" of
$16,667.00 per month representing lost rent for one of the
buildings to be demolished to make room for the Super K and was
also to pay up to $300,000.00 for costs of relocating one of the
tenants. See Ground Lease § §8(b). Prior to the Rental
Commencement Date, Kmart also was to continue to pay rent under the

Original Lease. The Original Lease provided for rent of $24,000.00

per month plus 1% of gross annual sales exceeding $12,500,000.00.


leasehold,® but not as a termination of the lease itself, the lease
nevertheless would have terminated under New Mexico law. Kmart
does not dispute that the ordinary rule under New Mexico law is
that a lessee's breach of a lease does not relieve it of the
obligation to pay remaining rent or of other remaining obligations
under the lease. However, the New Mexico Supreme Court has held
that, when a bankruptcy court approves a debtor-lessee's rejection
of a lease and orders the debtor to surrender possession of the
property to the lessor, the leasehold and related rights are
thereby extinguished. Mayfield, 896 P.2d at 1162-63. Contrary to
Sierra's contention, this appears to have been a holding based on
state law that was independent of the New Mexico court's discussion
of whether the lease in that case terminated upon rejection under
federal bankruptcy law.

Because the bankruptcy court's rejection
surrendered all property rights to the lessor, it
logically follows that there was an extinguishment
of the leasehold and any liens encumbering that
leasehold. . . . We hold that any lien that Com-

Quip may have had against the leasehold ended with

the bankruptcy's rejection of the lease and

termination of the leasehold.
Id. The focus in Mayfield was on the surrender of the property and
termination of the leasehold, not on the termination of the lease
itself. It is undisputed in the present case that the leasehold

(that is, the right to possess the premises) was terminated upon

rejection, even if the lease itself was not terminated. Thus, even

*‘There is no contention by Sierra that it was improper to
require that, upon rejection, Kmart surrender its Ground Lease
rights to possession of the Premises.

- 18 -


it was no longer premature to request that the stay be lifted so
that Sierra could obtain possession of the portion of the Shopping
Center that is the subject of the Original Lease. Both parties
represented that no evidentiary hearing was necessary to resolve
the automatic stay issue.

On March 25, 2003, the Bankruptcy Court orally ruled on the
pending motion to lift the stay, denying it. This is the ruling
from which Sierra has appealed. The Bankruptcy Court held that,
under either federal law or the law of New Mexico, the Ground Lease
terminated upon rejection, further specific performance was not
possible, and therefore a Rent Commencement Date terminating the
Original Lease never occurred. The Bankruptcy Court also held that
§ 45 was not an amendment to the Original Lease that continued in
effect as to the Original Lease regardless of the termination of
the Ground Lease. Kmart was granted until April 15, 2003 to elect
whether to assume or reject the Original Lease. Kmart had
previously indicated it would probably assume the Original Lease.

As part of its plan of reorganization, Kmart indicated its
election to assume the Original Lease. On April 23, 2003, the
Bankruptcy Court confirmed the First Amended Joint Plan of
Reorganization as Modified which incorporated the assumption of the
Original Lease. Sierra did not appeal from that order.

II. SEPARATE LEASES

The integration clause of the Ground Lease (§ 42) states

that the Ground Lease and its exhibits are the parties' entire

understanding regarding the Premises covered by the Ground Lease.


Minute Order Form (06/57)

'
United States District Court, Northern District of IHinois

6

lz
Name of Assigned Judge | | Sitting Judge if Other
or Magistrate Judge | Joan B. Gottschall than Assigned Judge
CASE NUMBER | 03 C 2513 DATE December 23, 2003
CASE ! In re Kmart Corp. (Sierra Vista Associates, LLC v. Kmart Corp.)
TITLE \
[ln the following box (a) indicate the party filing the motion, ¢.g., plaintiff, defendant, 3rd party plaintiff, and (b) state briefly the nature
MOTION: of the motion being presented]
DOCKET ENTRY: |
qa) Oo Filed motion, of [ use listing in “Motion” box above.]
Q oO Brief in support of motion due
G3) im] Answer brief to motion due. . Reply to answer brief due
4) Oo Ruling/Hearing on set for at
(5) o Status hearingfhel/continued to] [set for/re-set for] on set for at :
6) a Pretrial conferencefheld/continued to} {set for/re-set for] on set for at :
(es) Qo Trial{set forest for] on at
(8) ia} {Bench/Jury trial] (Hearing] held/continued to at
|
go: O This case is dismissed [with/without] prejudice and without costs[by/agreement/pursuant to]
O FRCP4(n) OLocal Rule 41.1. OOFRCP41(ay1) OO FRCP41(a)(2).
ao (Other docketentry] The Clerk of the Court is directed to enter judgment
in favor of appellee Kmart Corporation and against appellant Sierra
Vista Associates , LLC affirming the March 25, 2003 order of the
Bankruptcy Court in 02 B 02474 which was entered on the Bankruptcy
Court docket on March 31, 2003 (docket entry 9691).
|
Gg) [For further detail see memorandum opinion and order attached to the original minute order.]
No notices required, advised in onan court,
j No notices required. :
cd
' Notices mailed by judge’s staff. |
| Notified counsel by telephone. | |

( Docketing to mail notices,
\ Mail AO 450 form. _
Copy to judge/magistrate judge, dando Jginisia sn
Pr aoe a4 Wy 62900
( initials |

i penta



termination of the Ground Lease. Sierra does not dispute the
absence of an express statement that the Original Lease was
amended. Of course, an amendment could be made without using the
word "amend" or some form thereof. However, § 45 assumes the
coexistence of the two leases by stating that the Original Lease
will be terminated only upon the occurrence of a Rent Commencement
Date under the Ground Lease. That is different from making the new
termination date a provision of the prior contract, which is what
an amendment would effectuate. The termination of the prior
agreement was not a provision of the prior agreement, but rather a
provision of the new agreement. If, after entering into the Ground
Lease, the parties had agreed to end the Ground Lease without the
Rent Commencement Date having occurred, the Original Lease would
have remained in full force and effect, entirely unaffected by the
Ground Lease.

Thus, the Ground Lease was a contract distinct from the
Original Lease, not an amendment of the Original Lease. Such a
construction is consistent with the surrounding circumstances,
including the parties' intent, as expressed in § 6(g) of the Ground
Lease, that the Big K store was to remain open and functioning for
as long as practicable during the Preliminary Term of the Ground
Lease and possibly for longer as well.

Irr. EFFECT OF REJECTION

Under § 45 of the Ground Lease, the Original Lease is

terminated "only upon the occurrence of the Rent Commencement Date”

as provided in the Ground Lease. Section 1 of the Ground Lease

-ll-


particularly any merger, integration, or substitution provision
contained in the later contract. See, e.g., id. ("The 1996
agreement unambiguously contemplates that it is a substitute for
the 1960s contract."). Compare Fontbank, Inc. v. CompuServe, Inc.,
138 Ohio App. 3d 801, 742 N.E.2d 674, 682-83, appeal denied, 90
Ohio St. 3d 1493, 739 N.E.2d 817 (2000). "The issue of whether a
new contract is intended to govern over a prior agreement is
answered by the same analysis that applies to the enforceability of
any contract." Richards, 62 P.3d at 324. Additionally, any
presumption that arises is a rebuttable presumption, not an
irrebuttable presumption. See Bruggeman v, Jerry's Enterprises,
Inc., 591 N.W.2d 705, 710 (Minn. 1999).

Here, the contracts do not cover exactly the same subject
matter. They cover different areas of the Shopping Center that
have a partial overlap. There is also a provision in the later
contract regarding the termination provision in the earlier
contract. Under such circumstances, the presumption should not be
as strong as when two contracts cover identical subject matter. In
any event, any presumption that might arise as to substitution is
overcome by the plain language of § 42 and § 45 of the Ground
Lease, which, as explained above, provides that the Original Lease
will remain in force until terminated in accordance with § 45 of
the Ground Lease.

Additionally, the language of the Ground Lease is
inconsistent with Sierra's contention that § 45 of the Ground Lease

was an amendment to the Original Lease that survived any

~10-


On September 5, 2002, Sierra moved to shorten the time for
Kmart to make its election regarding the Ground Lease. on
October 10, 2002, Sierra moved for an order lifting the stay
regarding the Original Lease so that it could evict Kmart from the
Big K located at the Shopping Center. On October 16, 2002, Kmart
moved for an order permitting it to reject the Ground Lease on 10
days notice to Sierra. In an order dated October 30, 2002, Kmart
was granted permission to reject the Ground Lease, the rejection to
be effective 10 days after it provided notice to Sierra. As of the
rejection date, Sierra would be entitled to possession and Kmart
was to pay pro-rated rent from the January 22, 2002 filing of the
bankruptcy petition until the rejection date. Sierra's motion to
lift the stay was denied as being premature. Sierra did not appeal
‘either of the Bankruptcy Court's rulings. The motion to shorten
the deadline for Kmart's Ground Lease election was continued.

Kmart sent a notice of rejection of the Ground Lease that
was effective December 6, 2002.3 On December 30, 2002, taking the
position that, based on § 45 of the Ground Lease, the Original
Lease had terminated on December 14, 2002, Sierra filed a motion
requesting that the automatic stay be lifted as to the Original

Lease and the Big K store. If the Original Lease had terminated,

°A copy of the notice of rejection is not cited by the
parties nor has it been found in the record. In its opening
brief, Sierra stated December 6 was the date of the notice,
Appellant Br. at 7, and also that December 12, 2003 (sic) was the
date of rejection, id. at 14. In its reply, Sierra states
December 6 is the effective date, Reply at 2, and all other
indications, including an express finding by the Bankruptcy
Court, are that the effective date of rejection was prior to
December 14, 2002.


appropriate to deny the motion to lift the stay since the only
stated purpose for lifting the stay was to permit the eviction of
Kmart because the Original Lease had terminated.

Since the Bankruptcy Court is being affirmed on the merits,
it is unnecessary to consider Kmart's additional arguments that
Sierra waived all issues by making concessions in its arguments to
the Bankruptcy Court and by failing to appeal the October 30, 2002
order or the April 23, 2003 confirmation order.

IT IS THEREFORE ORDERED that the Clerk of the Court is
directed to enter judgment in favor of appellee Kmart Corporation
and against appellant Sierra Vista Associates, LLC affirming the
March 25, 2003 order of the Bankruptcy Court in 02 B 02474 which
was entered on the Bankruptcy Court docket on March 31, 2003

(docket entry 9691).

ENTER:

& he GOTTSCHALL
ited States District Judge

DATED: DECEMBER 23, 2003


amended in 1979. The Original Lease provided that a 25-year term
was to expire on September 30, 2003. Under the Original Lease,
Kmart has renewal options that would entitle it to continue to
lease the property for an additional 50 years after September 2003.
The Original Lease pertains to an area of the Shopping Center that
is approximately 14.3 acres and upon which a Big K store has been
operated,

In 2001, Kmart approached Sierra regarding the possibility
of replacing the Big K store with a larger Super K store. on
May 14, 2001, the parties entered into the Ground Lease, which was
amended on October 31, 2001. The Super K was to cover an area of
the Shopping Center measuring approximately 11.7 acres. A few
acres of the Super K location overlap with the location covered by
the Original Lease. The intent of the parties was to permit Kmart
to avoid, or at least minimize, any gap between the closing of the
Big K and the opening of the Super K. It was also the intent of
the parties that Sierra, which had to remove other tenants from the
Super K location, would begin receiving higher lease payments
within a time certain. The provisions of the Ground Lease that are
pertinent to today's ruling are as follows:

1. Definitions. For purposes of this

Lease, the following terms shall have the
following meanings:
wk ko

Rent Commencement Date: Subject to any
other applicable provisions of this Lease, the
earlier of (i) the date on which Lessee opens the
Kmart Building [Super K] for business to the
general public, or (ii) nineteen (19) months after
the date of this Lease (December 14, 2002].

kok ok



The Bankruptcy Code is unclear as to the effect of a
rejection. Section 365(g) provides that rejection constitutes a
breach of contract. Some courts have read this as meaning that
rejection is merely a breach and cannot constitute a termination of
the contract unless the contract makes the breach a termination.
See, e.g., Miller, 282 F.3d at 877-78; In re Modern Textile, Inc.,
900 F.2d 1184, 1191 (8th Cir. 1990); N. alt sociates v
Lichtenstein, 238 B.R. 249, 255 (S.D.N.Y. 1999); In re Pre-Press
Graphics Co., 300 B.R. 902, 909 (Bankr. N.D. Ill. 2003). Section
365(d) (4) provides that, when the debtor fails to make the § 365
election as to a lease for nonresidential real property within the
time allowed, the lease will be deemed rejected and the trustee
must immediately surrender the property to the lessor. Some courts
have read that provision as meaning that rejection by a debtor-
lessee, whether affirmatively or by default, constitutes a

termination of the lease. See, e.g., In re 6177 Realty Associates,

Inc., 142 B.R. 1017, 1019 (Bankr. S.D. Fla. 1992); In re Giles

Associates, Inc., 92 B.R. 695, 698 (Bankr. W.D. Tex. 1988). The
provisions of sections 365(h), (i), and (n), which permit
rejections to be treated as terminations under specified
circumstances, have been read as implying that a rejection is not
automatically a termination. See In re Austin Development Co., 19
F.3d 1077, 1082-83 (6th Cir.), cert. denied. 513 U.S. 874 (1994).

The case law, as well as commentators, have been split
regarding the effect of rejection. Apparently a majority of cases

have held that rejection of an executory contract or unexpired

-14-


Sommer, eds., 15th Rev. Ed. 2000), with Bartell, supra. See also
Whalen, supra.

While § 365 is not clear as to the effect of a rejection of
a nonresidential lease by a debtor-lessee, the various provisions
of § 365 can be consistently construed as indicating the effect of
such a rejection. The rejection is to be treated as a breach of
contract for purposes of determining the appropriate amount of
damages to be awarded as an unsecured, prepetition claim of the
lessor. To the extent the lease is not otherwise terminated, the
nondebtor-lessor may also rely on the breach to exercise any right
it may have to terminate because of a breach. Ordinarily, the
debtor will be required to surrender the property upon rejection,
though particular circumstances may call for other action to be
taken. Whether the lease is terminated will depend on the
particular circumstances, but ordinarily, if the property is
surrendered, the lease should also be terminated. See Sea Harvest
Corp. v. Riviera Land Co., 868 F.2d 1077, 1080-81 (9th Cir. 1989);
6177 Realty, 142 B.R. at 1019; In re Radco Merchandising Services,
Inc., 111 B.R. 684, 688 (N.D. Ill. 1990); Whalen, at D-12-13;

Bartell, 103 Dick. L. Rev. at 529. See also In re Henderson, 245
B.R. 449, 453-54 (Bankr. S.D.N.Y. 2000). But _see Austin, 19 F.3d
at 1082-83. Whether to require surrender and whether to treat the

lease as terminated would be within the discretion of the

- 16-


before the Big K store was closed or the Super K store opened,
Kmart went into bankruptcy and Kmart chose to reject the Ground
Lease. Kmart contends that the rejection of the Ground Lease
prevented the condition from occurring that would have terminated
the Original Lease, and therefore it can continue to operate the
Big K store under the terms of the Original Lease, which includes
a provision permitting Kmart to renew the lease for an additional
50 years. Sierra contends that the condition for termination of
the Original Lease came into being despite the rejection of the
Ground Lease and therefore Kmart is no longer entitled to
possession of the property on which the Big K is located. Sierra
moved to lift the automatic stay so that it could pursue state
court eviction proceedings in order to obtain possession of the
property. The Bankruptcy Court denied Sierra's motion because it
found that the Original Lease was still in effect, entitling Kmart
to continue to lease the property, and obviating any need to lift
the stay in order to bring eviction proceedings. Sierra has
appealed that order.
I. FACTS

The parties do not dispute the facts pertinent to this
case.* The Original Lease was entered into in 1977 and was between

predecessors to the current parties. The Original Lease was

*The parties generally do not cite to the record to
support any of their factual representations. Most of the facts
are simply the terms of the leases, copies of which are in the
record, or the proceedings that occurred in the Bankruptcy Court.
As to other facts, the uncontradicted representations contained
in the briefs will be taken as true.


IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION

IN RE:
Case No. 03 € 2513
KMART CORPORATION, et al.
Judge Joan B. Gottschall
Debtors.

SIERRA VISTA ASSOCIATES, LLC, Appeal from the United
States Bankruptcy Court
Appellant,
No. 02 B 02474

Susan Pierson Sonderby

Bankruptcy Judge

Vv.

KMART CORPORATION,

Appellee.

QO: ORD:

This is an appeal from the Bankruptcy Court's denial of a
motion to lift the automatic stay. Under terms of a lease (the
"Original Lease"), debtor Kmart Corporation’ leased property from
Sierra Vista Associates, LLC ("Sierra") on which a Big K store was
operated. The property was located at Sierra Vista Shopping Center
{the "Shopping Center") in Albuquerque, New Mexico. The parties
later entered into a lease (the "Ground Lease") for an overlapping
portion of the Shopping Center on which Kmart intended to operate
a Super K store. Under the terms of the Ground Lease, the Original
Lease was to terminate at a certain point and the Ground Lease was

to be the only remaining lease between the two parties. However,

petition, the party will be referred to simply as "Kmart.”TM
present purposes, it is unnecessary to specifically recite that
some of the conduct is by the bankruptcy trustee.

4Both before and after the filing of its bankruptcy \7
For


defines the Rent Commencement Date as being the earlier of two
possible dates.’ One possible date was the opening of the Super K.
Since the Super K never opened, this Rent Commencement Date trigger
never occurred and the Original Lease never terminated under this
clause. That leaves December 14, 2002 as the only possible Rent
Commencement Date. The question is whether the Original Lease
terminated on that date even though the Ground Lease had been
rejected prior to December 14, 2002, namely, on December 6. The
Original Lease did not terminate if either (a) § 45 was no longer
effective because of the rejection of the Ground Lease or
(b) rejection of the Ground Lease meant that the Rent Commencement
Date did not "occur" as was necessary for termination of the
Original Lease.‘

In accordance with 11 U.S.C. § 365(g) (1), Kmart's rejection
of the lease constituted a breach of the lease effective the day
before the Chapter 11 petition was filed, that is January 21, 2002.
The effect of relating back the breach is that any damages which

Sierra may be able to claim based on the breach is deemed a

prepetition, unsecured claim. See In re FBI Distribution Corp.,

5In accordance with § 30(i) of the Ground Lease, it was
also possible that the Rent Commencement Date could be modified.
Modification under that provision, however, did not occur,
leaving only the two possibilities discussed in the text.

‘The provision of § 7(e) of the Ground Lease regarding
confirmation of the Rent Commencement Date does not affect
whether of not the Rent Commencement Date occurred. Written
confirmation of the Rent Commencement Date is only required if
one party requests it. Moreover, the written confirmation only
acknowledges in writing the date of an event that has already
occurred; the written confirmation does not itself trigger the
Rent Commencement Date.

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lease results in termination. See Laura B. Bartell, Revisiting
Rejection: ecured art nte s s__in 2 & Executo

Contracts, 103 Dick. L. Rev. 497, 499 n.7, 500 n.9, 531-32 & n.106
(1999). A recent count limited to cases involving unexpired leases
finds a slim majority of cases favoring that rejection of a lease

results in termination of the lease. See Jerome D. Whalen,

Practising Law Institute Commercial Ground Leases App. D at D-4-6

& nn.21-26 (2003).7 One treatise suggests that the case law is
more guided by the possible effects of termination and the court's
perceptions of the equities of the case (e.g., whether one party
will receive a windfall or whether a third-party will be unfairly
and adversely affected) than by a reasoned construction of the

statutory scheme. See James F. Queenan, Jr., Philip J. Hendel, &

Ingrid M. Hillinger, Chapter 11 Theory an ractice: Gui
Reorganization § 18.22 at 18:80-81 (1994). Commentators have also

disagreed regarding the effect of rejection. Compare Michael T.

Andrew, Executory Contracts in Bankruptcy: Understanding

"Rejection", 59 U. Colo. L. Rev. 845 (1988); Michael T. Andrew,
Executory Contracts Revisited: A Reply to Professor Westbrook, 62
U. Colo. L. Rev. 1 (1991); Jay Lawrence Westbrook, A_Functional
Analysis of Executory Contracts, 74 Minn. L. Rev. 227 (1989); and
Collier on Bankruptcy ZI 365.09[3] (Alan N. Resnick & Henry J.

7As to the termination effect, there may be differences
between unexpired leases and executory contracts such that cases
decided regarding one may not be persuasive authority regarding
the other. Whalen, App. at D-4 n.22.

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