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. e du/thir dc ir c uit_1998/100Filed 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 De laware entered in connection with the Chapter 11 proceedin g of Trans World Airlines, Inc. ("TWA") which rejected I nterface's

___________________________________________________ ______________

* Hon. Phyllis A. Kravitch, Senior United States Ci rcuit Judge for the Eleventh Circuit, sitting by designation.

2claim for interest on its administrative claims, re jected 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 Interfa ce's damages.

I.

The material facts underlying this appeal are not i n dispute. Interface, which is in the business of, am ong other things, arranging and packaging vacation tours, pur chased

two 1973 Lockheed L-1011s in 1988 from the Manufacturer's Hanover Trust Company, which had bee n leasing the planes to TWA. Interface paid a total o f $25,200,000 for the two planes, financing 100% of t he 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 i n late 1990 or early 1991. Interface brought suit and obta ined an order of attachment for the planes from a Californi a state court. Thereafter, negotiations between TWA and Int erface

resumed and culminated in the execution of a new le ase dated May 1, 1991. Many of the terms of the 1991 le ase ("the lease") remained unchanged from the prior ter ms. Some changes were made, however, including a reduct ion in the monthly rent from $175,000 to $160,000 per p lane and an extension of the lease term to January 31, 1 996. The new lease also added a provision entitling Inte rface to withhold as a form of security deposit approximatel y $1,478,000 that it owed to TWA for work that TWA ha d performed on other Interface aircraft until TWA com pleted 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 pr ovision contained in the original lease was valid, reasonab le and

enforceable.

On January 31, 1992, TWA voluntarily filed for prot ection in bankruptcy under Chapter 11 of the United States

3Bankruptcy Code. Two months later, it defaulted on the

lease payments to Interface due April 1, 1992. With in 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 af ter March 31, 1992. In addition, the order made clear t hat 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 def ault and continued to make all payments through Septembe r 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 a s of October 24, 1992, but continued to use the Interface engine s on other planes in its fleet. On November 12, 1992, th e bankruptcy court granted TWA's motion to reject the lease. Nevertheless, TWA did not make the aircraft availab le to Interface until December 3, 1992. At that time, Int erface requested TWA to keep the two planes until after th e Christmas holiday, and took actual physical possess ion 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 m itigate its damages by either selling or leasing the planes, bu t there had been a precipitous downturn in the airline indu stry, and its efforts were unavailing. As a result, Inter face was forced to place the two L-1011s in long-term or "de ep" storage in Arizona.

On November 13, 1992, the day after TWA rejected th e lease, Interface filed a claim for administrative e xpenses 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
,

4Interface argued that it was entitled to the liquid ated

damages provided for in the lease as a result of TW A'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 sough t 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 bankrupt cy court rejected that argument, TWA contended, inter alia, that (1) the liquidated damages provision was void as contra ry 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 miti gate its damages, and (4) Interface's loss as a result of th e condition of the aircraft on return should be offset by the $ 1,478,000 security deposit it was holding for the OP-16 overh auls TWA had been obliged to perform at a future date.

In a brief oral opinion, the bankruptcy court concl uded that (1) the liquidated damages provision was penal rather than compensatory and, therefore, was unenforceable , (2) Interface's attempt to mitigate its damages was suf ficient, (3) the planes, or at least their engines, were bei ng 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, 199 2, (5) damages resulting from the return condition maintenance deficiencies and from rents accruing af ter December 10, 1993 were recoverable only as unsecure d claims, (6) the monthly rent recoverable would be $ 133,000 per plane as opposed to the $160,000 provided for i n the lease, (7) Interface was entitled to damages result ing from

TWA's maintenance deficiencies in the amount of $1,175,149, and (8) the amount of Interface's unsec ured 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

5form" by counsel for Interface, granted Interface a n

unsecured claim of $9,453,231 and an administrative claim of $617,918, representing $133,000 per month per pl ane from October 1, 1992 -- the date of the breach-- th rough December 10, 1992. In addition, the order provided that "Interface's Motion for Payment of Administrative R ent is, except as resolved by the foregoing provisions of t he Order, hereby denied." App. at 581. The order was signed b y 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 jud ge, who prepared a report and recommendation. Both parties filed objections thereto in the district court. In a thor ough opinion, the district court reviewed the magistrate judge's report and recommendation de novo and made the foll owing ten findings: (1) the bankruptcy court did not abus e its discretion in permitting Interface to pursue a gene ral unsecured claim; (2) the proper time period for Int erface's

administrative claim was from the date of the breac h through the date on which TWA made the planes avail able to Interface or, in other words, October 1, 1992 th rough December 3, 1992; (3) the bankruptcy court erred in denying administrative expense status to the damage s flowing from TWA's failure to meet the return maint enance conditions; (4) Interface's claim for unjust enrich ment 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 presen t value; (7) Interface's request for interest on its adminis trative 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) w as likewise waived; (9) Interface was entitled to an u nsecured, prepetition claim for its costs associated with sto ring the aircraft after repossessing them; and (10) the bank ruptcy court erred in setting off the $1,478,000 OP-16 sec urity 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

6lease'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 becau se the bankruptcy court (a) improperly reduced the amount of the administrative monthly rent from $160,000 as provid ed in lease to $133,000 and (b) improperly awarded Interf ace $189,000 for only one "C" maintenance check while T WA had failed to perform a "C" check on either plane i n 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 acco unt of its failure to file a proper proof of claim, (2) th e district court erred in holding that the damages resulting f rom TWA's failure to meet the return maintenance condit ions 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 pro visions of

the lease.

II.

Because the district court sat as an appellate cour t reviewing an order of the bankruptcy court, our rev iew of its determinations is plenary. In re Continental Ai rlines, 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 re view 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 le gal determinations de novo, its factual findings for cl ear error and its exercise of discretion for abuse thereof. I n re Engle, 124 F.3d 567, 571 (3d Cir. 1997) . We have jurisdic tion 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 interes t on the administrative portion of its claim. In declining t o do so, the district court stated that the bankruptcy court had not

7addressed the issue, Interface had never explicitly

requested a ruling from the bankruptcy court, and I nterface "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, Interfa ce 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 th at
Interface had waived the issue before both courts. In the course of reaching this conclusion, the court highl ighted the novelty and complexity of the issue and recogni zed that

the various courts that have addressed it have take n differing approaches and have reached different conclusions. Noting also that the bankruptcy court had not had the opportunity to apply its unique expertise i n 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 w aived. Both the bankruptcy court and the district court ha d granted Interface administrative status on the rent s owing from October 1, 1992 through early December, 1992, with the district court reducing the end of the period f rom December 10 to December 3. The district court, unli ke the bankruptcy court, held Interface was also entitled to an administrative claim for its damages for TWA's fail ure to return the planes in the condition specified in the leases. These two figures constitute the administrative cla im on

which Interface contends it was entitled to interes t.

Entitlement to interest on an administrative claim is an

issue that this court has never addressed. As the d istrict court recognized, the question whether to award int erest on
an administrative trade debt is an issue of conside rable complexity that has engendered a wide array of appr oaches and conclusions in the courts. The Bankruptcy Code does not expressly address the issue. As a result, court s have attempted to resolve the issue by turning to pre-Co de case law, analogizing to the treatment of awards of inte rest on tax claims and balancing the interests that animate much of the Code -- namely, the necessity of encouraging

8creditors to continue dealing with bankrupt debtors and the

often antagonistic concern not to deplete the estat e through excessive awards of high priority administrative cl aims. As

one of our sister circuits has stated "the diversit y 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 adminis trative trade debts). But see In re United Trucking Serv., Inc., 851 F.2d 159, 164-65 (6th Cir. 1988) (noting division a mong the courts and concluding that the allowance of interes t is usually not appropriate).

In this context we examine whether Interface fairly placed the novel and complex claim of its entitlement to i nterest on its administrative claim before the bankruptcy cour t and the district court. Interface contends that it pres erved 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 lea st]." App. at 72 (brackets in original) (emphasis added). Else where in its amended proof of claim, Interface again stated that it was seeking an administrative claim in the amount o f "$22,517,867.00 (plus interest)" (emphasis added). There

was no reference to interest other than the two und erlined above. The proposed joint pretrial order states mer ely that "Interface seeks interest and legal fees, as provid ed in the Lease and by law." App. at 34. Interface contends t hat it had no further opportunity to press its demand befo re the bankruptcy court.

We have substantial question whether these slight references really were sufficient to give the bankr uptcy court notice that Interface was seeking an award of interest on the administrative claim. However, the bankruptc y court itself, when reading from the proof of claim, noted at the hearing that Interface claimed "$22,517,867, plus i nterest." App. at 403. Although we believe the district court may have reasonably concluded Interface did not give th e requisite notice of its claim to the bankruptcy cou rt, in light of Interface's reference to interest in both its pr oof of claim and the joint pretrial order, and the bankruptcy co urt's reference to the claim for interest, we prefer to r est our

9holding on a different ground, i.e., Interface's fa ilure 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 o rder. Fed. R. Bankr. P. 8006. Interface timely filed such a statement and listed ten separate issues. Not one o f 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 Interfa ce's administrative claim to only $617,918," is broad en ough to encompass its claim for interest. We do not agree. The issue

of the amount of the administrative claim and the i ssue of

whether interest is awardable on that claim are conceptually distinct issues implicating very diffe rent factual and legal analyses.

In addition to Rule 8006, Bankruptcy Rule 8010 is a lso 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 appel late

briefs filed in the district court contain a statem ent of the issues presented, and requires that the argument se ction of the appellant's brief "shall contain the contention s 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 no t only a technical or aesthetic provision, but also has a su bstantive function--that of providing the other parties and t he 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) (loo king to cases interpreting Rule 28 for guidance in interpre ting Rule 8010). See also In re Suncoast Airlines, Inc., 188 B.R. 56, 58 n.2 (S.D. Fla. 1994) (same). Thus, a district co urt may, in its discretion, deem an argument waived if it is not presented in accordance with Rule 8010. See In re B rown Family Farms, Inc., 872 F.2d 139, 142 (6th Cir. 198 9). We

therefore review the district court's determination for abuse

of discretion. Id.

10As the district court correctly stated, Interface d id not

mention the issue of the appropriateness of an awar d 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 co nclusion then provided simply that "[i]nterest on administra tive trade

debt is allowable as an administrative claim. In re Colortex Indus., 19 F.3d 1371 (11th Cir. 1994)." Finally, th e schedule referenced in the conclusion stated in a f ootnote that "[t]o the extent deemed administrative, all am ounts should bear interest (See `Conclusion')."

In clear disregard of the mandate of Rule 8010, Int erface

did not set forth the issue in a statement of issue s 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 o r had discussed the issue to any extent. Indeed, the refe rences in the conclusion do not even suggest whether Interfac e 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, fa iled to make any reference to interest in her Report and Recommendation to the district court. Thus, we cann ot say that when Interface raised this issue in its object ions to that Report, the district court abused its discreti on in holding that Interface had waived its request for i nterest on
its administrative claim.

When the district courts are sitting on appeal, the y 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, 17 8 (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 generall y should not address legal issues that the parties have not developed through proper briefing"); Commonwealth of Pa. v. H HS, 101 F.3d 939, 945 (3d Cir. 1996) (arguments mention ed in

11passing but not squarely argued will be deemed waiv ed)).

See also United States v. Voigt, 89 F.3d 1050, 1064 n.4 (3d Cir.) ("The failure to raise a theory as an issue o n appeal constitutes waiver . . . [and] briefs must contain statements of all issues presented for appeal, together with s upporting arguments. . .." (emphasis in original) (internal c itations omitted), cert. denied, 117 S. Ct. 623 (1996); Nagl e v. Alspach, 8 F.3d 141, 143 (3d Cir. 1993) ("When an i ssue is either not set forth in the statement of issues pre sented or not pursued in the argument section of the brief, t he 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 preserv e an issue on appeal where it is contained in neither th e statement of issues on appeal nor the argument sect ion of the brief).

Interface, apparently in recognition of the force o f TWA's waiver contention, argues that even assuming that t he issue had not been presented below, this court shou ld nevertheless reach and decide it because it is a pu re 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 c ourt and the district court erred in holding the liquida ted damages clause in the lease to be unenforceable. Th e liquidated damages provision provides:

SECTION 17. REMEDIES. Upon the occurrence of any Event of Default . . . Lessor may, at its op tion, declare this Lease to be in default and at any time thereafter, . . . Lessor may do one or more of the follo wing with respect to all or any Aircraft as Lessor . .

.

(c) . . . Lessor, by written notice to Lesse e specifying a payment date . . . , may demand that Lessee pay to Lessor, on the payment date specified in suc h 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 perio ds prior to

12the Rental Payment Date specified in such no tice 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 T ermination Value for such Aircraft, computed as of the Rental Payment Date specified for payment in such n otice, over the aggregate fair market rental value . . . of such

Aircraft for the remainder of the Term for s uch Aircraft after discounting such fair market rental va lue monthly for the remainder of the Term . . . ; or (ii ) an amount equal to the excess, if any, of the Terminat ion Value for such Aircraft as of the date specified in su ch notice over

the fair market sales value . . . as of the Rental Payment Date specified for payment in such n otice.. . .

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, wa rrants and agrees that the liquidated damages claus e found at Section 17 of this New Lease (as was Section 17 of the Old Lease) is valid, enforceable and negotia ted at arms length by parties of equal bargaining power, with the harm difficult to estimate, and based on rea sonable valuations as known or possible in the futur e. TWA . . . shall indemnify and defend Lessor, and each of its successors, in the defense of Lessor's asser tion of

Section 17.

App. at 702 (emphasis added).

The lease contains a choice of law provision callin g for the application of New York law. New York's law reg arding the enforceability of liquidated damages provisions is welldefined. "A liquidated damages provision has its ba sis 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 a re 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).

13At the same time, the public policies of New York a re

"firmly set against the imposition of penalties or forfeitures for which there is no statutory authority." Truck R ent-ACenter, 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 liqui dated bears a reasonable proportion to the probable loss and the amount of actual loss is incapable or diffic ult of precise estimation. . . . If however, the amount fix ed is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not b e enforced.

Pyramid Centres & Co., Ltd. v. Kinney Shoe Corp., 6 63 N.Y.S.2d 711, 713 (App. Div. 1997) (internal citati ons omitted) (emphasis added).

Courts must apply this analysis from the parties' perspective as of the date of the contract rather t han from the date of the breach, Truck Rent-A-Center, Inc., 361 N.E.2d at 1019, and must resolve all doubts in favo r of a construction that invalidates the provision as a pe nalty, 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 rea sonable relationship to Interface's actual damages and was an unenforceable penalty. In like vein, the district c ourt concluded that the liquidated damages provision of the lease was unenforceable on the ground that actual d amages were easily calculable and the provision, when writ ten, bore no relation to Interface's anticipated actual damag es. Dist. Ct. Op. at 22-29.

Although the language of the liquidated damages provision appears complex at first blush, its opera tion is straightforward and depends upon the ascertainment of two figures. One figure is the "termination value" of e ach 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 bre ach. The formula for liquidated damages set in S 17(c) is th at, upon

14breach, TWA would have to pay the predetermined

termination value less either the fair market renta l value, the option under S 17(c)(1), or the resale value, t he option under S 17(c)(ii).

The termination value set by the lease for each pla ne in late 1992 was $13,500,000. From that figure would b e subtracted either the fair market rental value for the

remainder of the lease or the resale value as of Oc tober 1992. In late 1992, the airline industry was severe ly depressed and Interface's expert estimated the resa le value of the planes to be $7,000,000 each and the fair ma rket rental value to be $5,314,116 (39 remaining payment s at a fair market rent of $100,000 per month). TWA's expe rt arrived at similar, though slightly higher, figures

.

We do not purport to explain what motivated the par ties to arrive at this formula for liquidated damages. A s is evident from the calculations above, they simply ha ve no bearing on Interface's probable loss in the event o f breach. Interface has never explained to this court, and ce rtainly 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 rent al payments plus the consequential or incidental damag es Interface was likely to incur in mitigating its dam ages or storing the aircraft. As Interface forthrightly sta tes, however, "[t]hrough S 17(c), Interface sought to pr otect its multi-million dollar aircraft investment by shiftin g to TWA the risk of a market drop in the Aircraft's value. If TWA defaulted during the Lease, and delivered to Interf ace severely depreciated Aircraft, TWA would be respons ible 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 hypot hetical, if TWA were to breach with one month remaining on the lease, actual damages would be approximately one mo nth's rent per plane. Under S 17(c)(ii), however, TWA wou ld owe the termination value of $12,500,000 minus the resa le value at that time. Thus, using 1992 values, TWA wo uld owe $5,500,000 as liquidated damages per plane. Sim ilarly, under S 17(c)(i), TWA would owe the termination val ue 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 intende d to avoid precisely this type of penalty. See Truck Ren t-ACenter, Inc., 361 N.E.2d at 1018 ("A clause which p rovides for an amount plainly disproportionate to real dama ge is not intended to provide fair compensation but to se cure performance by the compulsion of the very dispropor tion. A promisor would be compelled, out of fear of economi c devastation, to continue performance and his promis ee, in the event of default, would reap a windfall well ab ove 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 a ctual loss.").

Interface, citing S 18.2 of the lease, apparently w ould have us disregard the requirement of proportionalit y because TWA expressly agreed to the formula as vali d and enforceable. Specifically, Interface contends that TWA was well represented and enjoyed equal bargaining power , that TWA never objected to the reasonableness of the liq uidated damages provision or requested that it be taken out of the lease and that consequently, it is "unseemly" for T WA now to claim that the provision is unenforceable. Inter face Br. at

24.

Although the district court initially expressed som e "concern" in light of S 18.2, ultimately it found t hat concern was not enough to render an otherwise invalid provi sion enforceable. Arguing to the contrary, Interface cit es several

cases in which the courts have noted that the contr acts at issue containing a liquidated damages provision wer e freely negotiated between parties with equal bargaining po wer. In re United Merchants, 674 F.2d 134, 144 (2d Cir. 198 2) (applying New York law); Walter E. Heller & Co. v. American Flyers Airline Corp., 459 F.2d 896, 899 (2d Cir. 19 72) (applying New York law); Rattigan v. Commodore Int' l, 739 F. Supp. 167, 172 (S.D.N.Y. 1990) (applying New Yor k law). See also Truck Rent-A-Center, Inc., 361 N.E.2d at 1 019-20; Leasing Serv. Corp. v. Justice, 673 F.2d 70, 74 (2d Cir. 1982) (applying New York law). In each of those cas es, however, the fact that the parties enjoyed equal ba rgaining

16power 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 e nforced an otherwise invalid liquidated damages provision m erely because it was freely negotiated by sophisticated p arties. Contracts that are void as against public policy ar e unenforceable regardless of how freely and willingl y they were entered into. See Restatement (Second) Contrac ts Ch. 8, Intro. Note (1981) (public policy concerns "touc h 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 p olicy."). The mere fact that TWA warranted the enforceability of the provision cannot negate the underlying public polic y.

Accordingly, we will affirm the district court's or der holding that the liquidated damages provision conta ined in

the lease is unenforceable.

C.

Interface next challenges the amount of two items o f actual damages awarded to it.

1.

The bankruptcy court's order effective March 31, 19 92, granting TWA's application under S 1110 effectively approved TWA's promise to continue to perform its obligations to Interface under the lease. Nonethele ss, 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 redu ced the rent of $160,000 a month provided in the lease to $133,000. The issue before us is whether, in the ev ent of a breach of a S 1110 agreement, the amount recoverabl e as administrative rent should be the amount provided f or in the lease (here $160,000 per month), as Interface a rgues, or the fair market rental value of the property at the time of

17the breach, representing the objectively reasonable value to

the estate, as TWA argues. This presents an issue o ffirst impression in this circuit, which implicates the sc ope 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 bankrup tcy, an automatic stay is imposed on claims against the deb tor's property. 11 U.S.C. S 362(a). Thus, if the debtor i s performing as lessee under an unexpired lease at th e time it files a Chapter 11 petition, the lessor subseque ntly cannot enforce its rights under the lease against t he 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 tr ustee 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 reorganizatio n. 11 U.S.C. S 365(a),(d)(2); see Sharon Steel Corp. v. N ational Fuel Gas Distrib. Corp., 872 F.2d 36, 43 (3d Cir. 1 989). If the lease is assumed, i.e., the debtor and the cour t having agreed that the continuation of the lease is in the best interest of the debtor's reorganization and continu ation, the

debtor is entitled to receive the benefits under th e lease but, at the same time, is responsible for performin g its obligations thereunder. In re Columbia Gas Sys. , 5 0 F.3d 233, 238-39 & n.8 (3d Cir. 1995). Should the debtor breach thereafter, all future payments due under the remai nder of the lease become administrative expenses with administrative priority. Id.

If the lease is rejected, a creditor's claim for th e stream of future rental payments due under the now-rejected l ease is denied post-petition administrative status and is t reated as an unsecured prepetition claim. Id. at 238 n.8. Whe re the debtor continued to use the leased property prior t o rejection, it is liable for the rental payments acc ruing during the period of use, and that obligation is tr eated as a S 503 post-petition administrative expense. Howev er, the amount treated as an administrative expense would n ot necessarily be the rent provided for in the lease, since

18administrative expenses are allowable only for "the actual,

necessary costs and expenses of preserving the esta te." 11 U.S.C. S 503(b)(1)(A). Thus, it is well-settled tha t under S 503 the debtor is responsible for only the fair m arket 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 f or the airline industry. Under S 1110 of the Bankruptc y Code, lessors of aircraft, inter alia, may avoid the auto matic stay and retake possession of the leased equipment unles s the airline takes certain required steps.

Section 1110 provides, in relevant part:

The right . . . of a lessor . . . of . . . a ircraft . . . leased

to . . . a debtor that is an air carrier . . . to take possession of such equipment in compliance w ith the provisions of a . . . lease . . . is not aff ected 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 or der for relief under this chapter, the trustee [or debtor-i n- possession], subject to the court's approval , agrees to perform all obligations of the debtor that b ecome 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 al l future defaults within 30 days of their occurrence. Id.

As is evident, S 1110 subtly alters the interplay b etween the provisions discussed above in the context of ai rcraft and aircraft equipment financing. Section 1110 was designed in part to increase availability of low-in terest capital to the transportation industry. See general ly In re Continental Airlines, Inc., 932 F.2d 282, 291 (3d C ir. 1991). Toward this end, S 1110 renders S 362's automatic s tay effective for only 60 days following the filing of the petition

___________________________________________________ ______________

1. Because all relevant events underlying the insta nt 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.

19in bankruptcy. After that time, the lessor is free to

repossess the aircraft in the event of breach by th e debtor unless, within those 60 days, the debtor enters int o what is referred to as a "S 1110 agreement." If a S 1110 ag reement is executed, which requires court approval but not the lessor's consent, the automatic stay remains in eff ect. In return for this protection, the debtor or its trust ee must "perform all obligations of the debtor that become due on or after such date [on which the S 1110 agreement is e ntered 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 oth er sections of the Code discussed above.

The House Report stated:

It should additionally be noted that under s ection 1110(a) the trustee or debtor in possession is not required to assume the . . . unexpired lease under section 1110; rather, if the trustee or debt or 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. Se pt. 28, 1978). A S 1110 agreement, then, operates neither a s an assumption nor as a rejection of the entire lease, but rather, obligates the debtor to perform the lease o bligations as they come due, in return for the protection of t he 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 t urn now to the question presented on appeal. That is, w hether

Interface's administrative claim for the rental obl igations coming due after the S 1110 agreement was entered i nto but before the planes were returned should be fixed at the $160,000 monthly rent provided for in the lease or whether

20it should be reduced to the fair market value as wo uld 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 pos session of the aircraft and continue to reap the benefits of t he automatic stay, it must "agree[ ] to perform all ob ligations.

. . that become due. . . under such. . . lease ." 1 1 U.S.C. S 1110(a) (emphasis added). Interface argues that t he phrase "under such . . . lease" indicates Congress' s intention to bind the debtor to the terms of its le ase, a reading supported by the legislative history to S 1 110. There, Congress made clear that

[t]he sections [1110 and its companion statu te 1168, pertaining to railroad rolling stock] protec t the interest of the financer by entitling him to payments according to the financing agreement terms or to his e quipment. They protect the estate and the reorganizati on process by leaving the choice of which the financer will get to the trustee. Thus, equipment that the truste e needs to keep operating the business is beyond reach by the financer if the trustee is willing to contin ue to pay for it according to pre-bankruptcy terms. If the tr ustee does not need the equipment, he may simply surren der 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 (1 5th ed. Rev. 1997). In addition, Congress indicated that le ssors 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 24 0, reprinted in 1978 U.S.C.C.A.N. at 6199. That is, th e lessor is entitled to "payments under the terms of the lea se." Id. In our view, these passages leave little doubt that under a S 1110 agreement, the lessor is entitled to the ful l rent provided for in the lease.

The only other circuit to have addressed a somewhat

similar issue reached a similar conclusion. In In r e Airlift Int'l, Inc., 761 F.2d 1503, (11th Cir. 1985), the q uestion presented was whether the financer, GATX Leasing Co rp.,

21was entitled to receive the amounts due under the t erms of

its agreement with the debtor-lessee or the value o f the

actual use of the aircraft to the debtor. The court determined that, in the context of a S 1110 agreeme nt, the lessor was entitled to the full amount provided for under the terms of the agreement. Id. at 1511 ("The amoun t of the administrative claim is determined by looking to th e amount due under the agreement."). The court in Air lift did not directly address the possibility of awarding th e fair

market value.

Neither the bankruptcy nor district court in this c ase held that Interface's recovery should be limited to the value of TWA's actual use of the aircraft, and TWA does n ot urge that position on appeal. Thus, although Interface r elies on Airlift almost exclusively, its holding is not dire ctly apposite.

Nevertheless, the Eleventh Circuit's general approa ch to the issue is illuminating. That court conceived of a S 1110 agreement as a post-petition agreement to meet prep etition 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 enfor cement of unnecessary or deleterious post-petition contrac ts, an administrative claim based on a post-petition contr act 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 o f an unexpired lease are in fact actual and necessary ex penses of the estate prior to the debtor's formal assumpti on or rejection. Thus, if the debtor rejects the lease, t he court may award an administrative claim for the post-peti tion

rents of less than the lease terms if it determines that those terms are significantly disproportionate to the mar ket 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 on ly after a court has determined that the lease obligat ions represent actual and necessary costs to the estate. Accordingly, having received court approval ex ante , there

22is no need to subject the agreement to the court's review for

a second time upon the submission of a creditor's c laim. Id. at 1509, 1510 n.5. TWA's S 1110 agreement was revie wed and approved by the bankruptcy court as being "in t he best interests of TWA, its creditors and its estate." Ap p. 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 whic h Interface was entitled, the bankruptcy court reduce d the monthly rent for the relevant period from $160,000, as provided for in the lease, to $133,000, which was t he figure provided by TWA's expert as the fair market rental value of

the aircraft in 1992. The district court did not al ter 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 Octo ber 1, 1992 through December 3, 1992.

2.

Interface also argues that the bankruptcy and distr ict courts erred when calculating its actual damages be cause they did not include damages for TWA's failure to p erform a timely "C" check on one of the two aircraft. Sect ion 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 ex pense, 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 fo llow the Eleventh Circuit's reasoning, TWA attempts to distinguish Ai rlift on the ground that GATX had voluntarily entered into and consente d 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 r easoned justification

for conditioning a creditor's entitlement to full payme nt on whether or not it consented to the formation of the S 1110 agreeme nt.

23App. at 662. A "C" check is a standard aircraft mai ntenance

overhaul which, according to the parties' joint pre trial 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 aircra ft no. N41012 on September 28, 1992. In addition, the dist rict 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 Decem ber 3, 1992. Thus, while the lease called for "C" checks t o be performed within 45 days of the return date, in fac t they were performed 139 days and 66 days prior to the re turn of

the aircraft.

For reasons not fully explained, the bankruptcy cou rt 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 pla inly entitled to damages for TWA's failure to perform a" C" check on the second plane within 45 days of its return, a s required under the lease. In opposition, TWA conten ds that Interface waived this argument on appeal to the dis trict court and that the bankruptcy court's award was not clearly erroneous because, according to TWA, Interf ace suffered no harm as the required "C" check was perf ormed on that plane only 66 days prior to the date it was made

available.

With respect to the alleged waiver, TWA contends th at in Interface's appeal to the district court it had arg ued only that the bankruptcy court had erred in calculating its actual damages, without specifically drawing attent ion 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 calcul ating its actual damages is broad enough to encompass the var ious instances in which Interface's damages might have b een underestimated. Moreover, in the argument section o f its opening brief submitted to the district court, Inte rface argued that the bankruptcy court erroneously awarde d it only a portion of its damages flowing from TWA's fa ilure to meet the return maintenance requirements contained in S 5 of the lease. Thereafter, Interface pressed the spe cific issue

24of the second "C" check in its reply memorandum,

describing its actual damages as "including a clear ly overdue `C' check." Although Interface could have m ade a more detailed argument, we cannot say that the issu e was waived.

TWA next argues that Interface was not harmed by it s failure to perform the second "C" check within 45 d ays of the return date and, therefore, that TWA should not be required to pay damages. However, the bankruptcy co urt made no finding that Interface suffered no harm. In deed, contrary to TWA's argument, its expert did not test ify to

that effect.

The bankruptcy court appears to have rejected the c laim for the second "C" check on the ground it had not c ome due by the date TWA rejected the lease. However, the le ase required TWA to perform the "C" check within 45 day s of the planes' return. TWA's expert agreed the "C" che ck was not performed within 45 days of the second plane's return. Accordingly, we must conclude that both the bankrup tcy and district courts erred in failing to award Inter face $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) affi rm the

district court's conclusion that Interface failed t o 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 u nder New York law, (3) reverse the district court's deci sion, 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 In terface be granted rent in the full lease amount of $160,00 0 per plane from October 1, 1992 through December 3, 1992
, and (4) reverse the district court's decision, whic h 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 aircraf t, and direct that its claim be increased by that amount. We turn to consider the cross-appeal.

25III.

A.

TWA raises three issues in its cross-appeal. First, it argues that the district court erred in affirming t he bankruptcy court's denial of TWA's motion to dismis s Interface's unsecured prepetition claim as untimely

.

Interface filed its "Amended Administrative Proof o f Claim" on September 23, 1993, well before the bar d ate of December 3, 1993 (the last day on which unsecured c laims could be filed). However, it had not filed an unsec ured

claim as such. At the close of Interface's case bef ore the bankruptcy court, TWA moved to dismiss Interface's entire unsecured claim on the ground that Interface hadfil ed only

an administrative claim and that the unsecured clai m had not been filed in time. Interface responded that it s September 23, 1993 filing was sufficient to constit ute 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 admin istrative expense status, and that TWA had been treating Inte rface'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 cl aim if the court deemed it necessary.

The bankruptcy court ruled as follows:

The Court is [ ]well-aware of the liberal a mendment rules. The sections of the Bankruptcy Code p rovide that an administrative expense claim may be requested and thus a proof of claim is not required fo r an administrative expense request. If there is to be a claim under Section 501, I believe it is, there mu st be a proof of claim filed if, in fact, the debtor's sch edules 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 a n amended

administrative claim. It also checked that t here's an unsecured priority claim, which is questiona ble as to what was meant by that.

26* * *

This Court has found that when an administr ative claim is disallowed that that portion for br each 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 comm its the decision to grant or deny leave to amend to the tri al 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 prejudice d by the bankruptcy court's allowance of Interface's uns ecured claim but rather that because no proper unsecured c laim had been filed before the bar date, any amendment o f 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 ambigu ous in that it mentioned both an administrative proof of c laim 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 th at an unsecured claim had been made against it and could be pursued. Thus, there is nothing in the record to su ggest 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, 1 434 (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. 19 93) (amendment of a claim under Fed. R. Bankr. P. 7015 should be granted where the purpose is to cure a de fect in the claim as originally filed, to describe the clai m with greater particularity or to plead a new theory of r ecovery on the facts set forth in the original claim). We will affirm both the bankruptcy court and the district court on this issue.

27B.

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 t he lease would be treated as an administrative claim, thereb y reversing the bankruptcy court's determination that it was a prepetition unsecured claim. There is little prec edent to help resolve this difficult issue.

Section 5 of the lease specified in detail the cond ition in

which the two L-1011 aircraft were to be returned t o 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 co ndition terms gives rise to an administrative rather than a n unsecured claim.

TWA reasons that this obligation did not come due b efore November 12, 1992, the date it rejected the lease, and thus its failure to meet the return conditions requireme nts 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, th e debtor is no longer bound by its terms. Under In re Contin ental Airlines, return obligations arising after rejectio n 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 rea ched a contrary conclusion. In In re United Trucking Servi ce, Inc., 851 F.2d 159 (6th Cir. 1988), the Sixth Circuit hel d that

the lessee's failure to meet return conditions bene fits the estate in the amount that the debtor/lessee would h ave to pay to meet those conditions and, therefore, the le ssor's claim for resulting damages should be given adminis trative priority. Id. at 162.

In the case before us, the district court reversed the holding of the bankruptcy court on the classificati on of the

return maintenance conditions. The district court n oted

that in neither In re Continental Airlines nor In r e United Trucking Service, had the debtor formally entered i nto a S 1110 agreement. Dist. Ct. Op. at 16 n.9. That dis tinction

28is critical. After TWA entered into the S 1110 agre ement, 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 1 110 itself. See Airlift, 761 F.2d at 1513 ("[t]hough th e Note set the parameters of Airlift's obligation, it is the s ection 1110 agreement that creates the binding contractual obli gations of Airlift"). Therefore, cases in which the debtor did not enter into a S 1110 agreement do little to inform o ur analysis.

TWA's argument that its obligation under the S 1110 agreement ceased when it rejected the lease would s tand on somewhat better ground if it had returned the aircr aft immediately upon rejection, which it failed to do. Ultimately, however, even then its argument would f ail because of the nature of the return condition oblig ation.

As we held above, as long as the debtor retains the leased property without assuming the lease, it must meet i ts obligations coming due in accordance with the stric tures of S 1110. Cf. In re Airlift, 761 F.2d at 1512 ("If th e 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 (1 5th ed. 1997) ("if the obligation that the trustee agrees t o perform under section 1110 is an obligation owing pursuant to a lease or executory contract, the trustee's agreemen t to perform should be enforceable until the time that t he 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 obligatio ns encompassed in the S 1110 agreement was the obligat ion under the lease to return the planes in a specified condition. Although the obligation fell due on a sp ecific 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 conditio n required by the lease. See generally Kathryn Hoff-P atrinos,

Aviation Finance Revisited: The 1994 Amendments to

29Section 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 mainte nance 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 cou rt did not err in holding that the damages flowing from TW A's

failure to meet those conditions should have been a fforded administrative priority.

C.

TWA's final contention on its cross-appeal is that the district court erred in reversing the bankruptcy co urt's decision to offset the amount of Interface's damage s resulting from TWA's failure to meet the lease's re turn maintenance requirements by the $1,478,000 security deposit that Interface held.

Section 33 of the lease authorized Interface to wit hhold $1,478,000 that it owed to TWA and to retain that s um as a "maintenance deposit" to be returned to TWA witho ut interest upon TWA's "completion of an OP-16 overhau l . . . on both Aircraft." App. at 708. Under TWA's FAA-app roved maintenance program, each overhaul in a progression of increasingly more thorough or "heavier" maintenance overhauls must be performed after a specified numbe r 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 otherw ise been
premature.

It is undisputed that OP-16 overhauls would have co st TWA over $2,000,000 per plane. It is also undispute d that TWA never performed an OP-16 overhaul on either air craft. TWA argues that it is entitled to a setoff in the a mount of the deposit because an OP-16 overhaul never came du e under TWA's FAA-approved maintenance plan. In respo nse, Interface cites the plain language of S 33 and argu es that because the OP-16 overhauls were never performed, i t is entitled to retain the security deposit.

30Without discussion, the bankruptcy court reduced th e

amount of Interface's award of damages for TWA's fa ilure 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 w as entitled to retain the entire security deposit beca use TWA had not performed an OP-16 overhaul on either aircr aft. Dist. Ct. Op. at 37. We agree. The $1,478,000 was n ot a general security deposit to protect Interface in th e event
that TWA failed to meet the return maintenance requirements. Rather, it was a specific deposit, ti ed only to the performance of the OP-16 overhauls. Whether Int erface is entitled to retain the deposit is analytically d istinct 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 w ere to return the planes before the OP-16 overhauls were d ue. Thus, S 33 not only protected Interface in the even t that TWA failed to perform OP-16 overhauls that were ove rdue, but shifted to TWA the risk of having to pay for th e OP-16 overhauls when due in the future. For example, in t he absence of a lease provision such as S 33, if TWA r eturned the planes immediately before the OP-16 overhauls b ecame due under S 5 of the lease, Interface would have be en left to

bear the entire cost of the overhauls. Section 33 a ssured Interface that, in the event of early termination, TWA would bear at least some responsibility for the cost of t he

overhauls.

Because S 33 reflected a reasonable estimate, ex an te, of the injury that Interface would incur if TWA termin ated the lease early, S 33 did not constitute an unenforceab le penalty under New York law. See Pyramid Centres & C o., Ltd. v. Kinney Shoe Corp., 663 N.Y.S.2d 711, 713 (A pp. 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 condition ed on TWA's performance of the OP-16 overhauls and that

31condition was never satisfied. Accordingly, Interfa ce is

entitled to retain the deposit and the district cou rt did not err in reversing the bankruptcy court's order setti ng off Interface's recovery against it.

D.

To conclude, on TWA's cross-appeal, we will (1) aff irm the

district court's denial of TWA's motion to dismiss Interface's unsecured claim as untimely filed, (2) affirm the d istrict court's grant of administrative status to Interface 's claim for damages flowing from TWA's failure to meet the retu rn conditions, and (3) affirm the district court's dec ision that TWA was not entitled to offset the $1,478,000 maint enance security deposit held by Interface against Interfac e'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

32