Opinion ID: 658305
Heading Depth: 2
Heading Rank: 1

Heading: The Indemnity Claims

Text: 13 Frito-Lay contends on appeal that the bankruptcy court and the district court erred in classifying Frito-Lay's contractual indemnity claims as pre-petition and general unsecured. Frito-Lay's indemnity claims are based on twenty-five agreements between Frito-Lay and two corporate predecessors of LTV Steel Company (Republic Steel Company and Jones & Laughlin Steel, Inc.) which agreements were entered into in 1981 and 1982 pursuant to the now repealed safe-harbor leasing rules of the 1981 Internal Revenue Code. 14 1. Safe-Harbor Leasing. Section 168(f)(8) of the Economic Recovery Tax Act of 1981 (Former Section 168(f)(8)) permitted certain corporations to enter into safe-harbor leases, also known as tax benefit transfer agreements. See Pub.L. 97-34, 95 Stat. 172 (1981); Temp. Income Tax Regs. (Former Temp. Regs.) Sec. 5c.168(f)(8), 46 Fed.Reg. 51908 (Oct. 23, 1981). Safe-harbor leases entered into pursuant to Former Section 168(f)(8) are tax-driven sale-leaseback arrangements designed so that certain unprofitable companies could raise revenue by separately marketing the tax benefits associated with certain types of business property without disposing of the property itself. A tax-benefit transfer agreement satisfying the requirements of Former Section 168(f)(8) affords a safe-harbor in the sense that it is treated as a sale-leaseback for federal tax purposes even where the parties do not comply with State law requirements concerning transfer of title, recording, etc. Former Temp.Regs. Sec. 5c.168(f)(8)-1(c). 15 In a typical safe-harbor lease under Former Section 168(f)(8), the owner of qualified property transferred the property's tax attributes by nominally selling the property for (1) a single cash payment, based upon the present value of the federal tax benefits associated with the property, and (2) an installment payment obligation, approximating the property's value net of those tax benefits. At the same time, however, the purchaser leased back that property to the seller in exchange for rental payments that offset the installment note payments dollar for dollar. The purchaser's payments under the note and the seller's rental payments were thus a series of wash transactions. The only cash that actually changed hands was the initial cash payment. At the end of the lease term--still, for federal tax purposes only--the seller/lessee repurchased the property for a peppercorn. See generally Armstrong World Industries, Inc. v. Commissioner, 974 F.2d 422, 424, 431-32 (3d Cir.1992); Tax Lease Underwriters, Inc. v. Blackwall Green, Ltd., 642 F.Supp. 1492, 1494 (E.D.Mo.1986); Joint Committee on Taxation Staff Pamphlet Analyzing Safe Harbor Leasing, 114 Daily Tax Rep. (BNA) J-29, 32 (June 14, 1982). 16 Pursuant to the Temporary Income Tax Regulations promulgated under the authority of Former Section 168(f)(8)(G), an asset loses its character as leased property under a tax benefit transfer agreement upon the happening of certain enumerated events. One of these disqualifying events is the retirement of the leased property. Former Temp. Regs. Sec. 5c.168(f)(8)-8(b). When a disqualifying event happens, as when LTV retired assets during the bankruptcy proceedings, the seller/lessee--having retained ownership of the leased property for all purposes other than Former Section 168(f)(8)--is deemed to have repurchased the property for federal tax purposes. Former Temp. Regs. Sec. 5c.168(f)(8)-8(d). The overall financial consequences of such a repurchase tend to be beneficial to the seller/lessee and detrimental to the buyer/lessor. For that reason, the buyer/lessor typically secured a contractual indemnification from the seller/lessee for any tax loss resulting from a disqualifying event, as Frito-Lay did here. 17 2. The Frito-Lay/LTV Agreements. Under the Frito-Lay/LTV safe-harbor leases, Frito-Lay purchased certain qualified property from LTV for (a) a cash payment of $189,460,229 (which, according to the parties, was based on the present value of the tax benefits to be transferred), and (b) a nonrecourse, interest-bearing note in an amount based on the property's remaining value. Frito-Lay then leased the property back to LTV for a period of twenty-two and a half years in exchange for monthly rental payments equal to the monthly installment payments due under the note. Frito-Lay was to enjoy the federal tax benefits of the qualified property until expiration of the lease term, at which time Frito-Lay would reconvey the assets to LTV for a token payment. The three leases submitted by the parties as representative contracts for purposes of this litigation confirm that, although Frito-Lay owned the qualified property for federal tax purposes during the lease term, LTV at all times retained the other attributes of ownership--including the power to bring about a disqualifying event by selling or retiring the assets. For example, the October 12, 1982 lease between Republic Steel Corporation (as seller/lessee) and Frito-Lay, Inc. (as buyer/lessor) contains the following provision (in which the qualified assets are designated Items of Equipment): 18 [T]his Agreement shall not (a) effect a transfer of legal or equitable title to any Item of Equipment from Lessee to Lessor, (b) grant to Lessor any possessory right whatsoever in any Item of Equipment, or (c) grant to Lessor the right to claim any possessory right with respect to any Item of Equipment upon the occurrence or nonoccurrence of any event or under any circumstances whatsoever, including, without limitation, upon the occurrence of any breach by Lessee of any of its obligations hereunder. Subject only to Lessor's right to claim Federal income tax deductions and credits with respect to each Item of Equipment as contemplated by this Agreement, Lessee shall retain all of the rights, benefits, incidents, burdens and obligations of ownership of each Item of Equipment, including, without limitation, the right to sell, transfer, assign or otherwise dispose of any Item of Equipment and the obligation to pay all state and local taxes, all insurance premiums and all maintenance charges with respect to each Item of Equipment.... The use and possession of each Item of Equipment by Lessee, and Lessee's rights therein, are not in any way conditioned on the payment of Basic Rental Payments or any other payments identified in this Agreement. 19 Section 7.01 (emphasis added). The same lease provides, however, that LTV will indemnify Frito-Lay for any resulting tax loss if LTV's ownership decisions interfere with Frito-Lay's right to claim federal income tax deductions and credits with respect to the qualified assets. 20 The qualified assets affected by the twenty-five safe-harbor leases were located at eighteen separate LTV production facilities. In 1987, after filing for bankruptcy protection, LTV permanently retired two of those facilities, one in Buffalo, New York, and one in Aliquippa, Pennsylvania. Those retirements caused the disqualification of a group of assets subject to the safe-harbor leases, and resulted in the return of tax benefits to LTV. According to Frito-Lay, the disqualifications compelled it to pay an additional $14 million in respect of its 1987 tax year alone. 21 3. Frito-Lay's Request for Priority. LTV has never disputed the validity of the safe-harbor leases or that LTV's indemnification duties were triggered when Frito-Lay suffered negative tax consequences resulting from the retirements of qualified property at the Buffalo and Aliquippa facilities. What is disputed is Frito-Lay's demand that its indemnification claims be afforded administrative priority status. In an opinion dated June 29, 1989, the bankruptcy court resolved the issue by granting summary judgment to the Debtors, on the ground that the safe-harbor leases do not constitute executory contracts or unexpired leases under Section 365 of the Bankruptcy Code and therefore that the indemnity claims are pre-petition, general unsecured claims which, as such, are not entitled to priority treatment under Sections 503 and 507 of the Bankruptcy Code. In re Chateaugay Corp., 102 B.R. 335 (Bankr.S.D.N.Y.1989). An order consistent with the June 29, 1989 opinion was entered on July 31, 1989. 22 The district court affirmed the bankruptcy court's grant of partial summary judgment on the ground that, whether or not the safe-harbor leases could be considered executory contracts or unexpired leases, Frito-Lay's indemnity claims could not be afforded priority status because no post-petition act of Frito-Lay conferred a post-petition benefit on the Debtors. In re Chateaugay Corp., 156 B.R. 391, 399 (S.D.N.Y. June 9, 1993); In re Chateaugay Corp., No. 89 Civ. 6687 (S.D.N.Y. Mar. 29, 1990). 23 The district court's June 9, 1993 order also affirmed the bankruptcy court's July 2, 1992 order, which (a) established the allowed amount of Frito-Lay's fixed indemnity claims, which are based on undisputed disqualifications that occurred during the bankruptcy proceedings, and (b) estimated at 80 percent Frito-Lay's contingent indemnity claims, which are based on possible future disqualifications and disputed past disqualifications. 24 4. Mootness. LTV's overarching position on appeal is that relief can no longer be granted to Frito-Lay because the Plan has been substantially consummated, and that the appeal should therefore be dismissed as moot. Substantial consummation of a reorganization plan is a momentous event, but it does not necessarily make it impossible or inequitable for an appellate court to grant effective relief. See, e.g., In re AOV Industries, Inc., 792 F.2d 1140, 1148 (D.C.Cir.1986) (substantial consummation is not a blanket discharge of judicial duty to examine carefully each request for relief). 25 In bankruptcy proceedings, the mootness doctrine involves equitable considerations as well as the constitutional requirement that there be a case or controversy. These concerns often cannot be addressed separately; they are interactive, as 'the finality rule limits the remedies a court can offer.'  In re Public Service Co., 963 F.2d 469, 472 (1st Cir.) (quoting In re Stadium Management, 895 F.2d 845, 847-48 (1st Cir.1990)), cert. denied, --- U.S. ----, 113 S.Ct. 304, 121 L.Ed.2d 226 (1992). Constitutional and equitable considerations dictate that substantial consummation will not moot an appeal if all of the following circumstances exist: (a) the court can still order some effective relief, Church of Scientology v. United States, --- U.S. ----, 113 S.Ct. 447, 449, 121 L.Ed.2d 313 (1992); (b) such relief will not affect the re-emergence of the debtor as a revitalized corporate entity, In re AOV Industries, Inc., 792 F.2d at 1149; (c) such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the Bankruptcy Court, In re Roberts Farms, Inc., 652 F.2d 793, 797 (9th Cir.1981); (d) the parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings, Central States, Southeast and Southwest Areas Pension Fund v. Central Transport, Inc., 841 F.2d 92, 96 (4th Cir.1988) (citations omitted); and (e) the appellant pursue[d] with diligence all available remedies to obtain a stay of execution of the objectionable order ... if the failure to do so creates a situation rendering it inequitable to reverse the orders appealed from, In re Roberts Farms, Inc., 652 F.2d at 798. 26 The value of Frito-Lay's potential recovery on its priority claims is in dispute. If successful on the merits, Frito-Lay asserts that it will be entitled immediately to approximately $20 million (the amount of Frito-Lay's claimed tax loss to date); LTV places Frito-Lay's maximum recovery on a priority basis at $875,000 (the amount of tax benefits LTV allegedly derived from retiring its assets). Under either calculation, Frito-Lay argues that relief can be granted so as not to unravel the reorganization plan or adversely affect parties not before this Court. Specifically, Frito-Lay seeks the recoupment of funds that (pursuant to the Plan) re-vested in LTV or were distributed to parties represented on this appeal. In response, LTV states (1) that such payment is inconsistent with the bankruptcy court's May 27, 1993 order (as affirmed by the district court's June 21, 1993 order) which directs that, upon the effective date, all assets not being held for distribution pursuant to the terms of the Plan are to re-vest in the debtor companies free and clear of all claims and interests, and (2) that such payment would severely deplete its $200 million in working capital upon which other creditors have relied in approving and consummating the Plan. No argument against recoupment of funds is advanced specifically on behalf of appellee The Official Committee of Unsecured Creditors of the LTV Corporation or on behalf of appellee The Official Committee of Unsecured Creditors of the LTV Steel Company, Inc. 27 Despite the present uncertainty as to how much money is at stake, and what parties might be liable for its payment, the appellees do not dispute that the only way Frito-Lay could win on the merits is upon a finding that Frito-Lay was entitled to funds that, at least to some extent, were wrongfully distributed to or wrongfully re-vested in one or more entities that are now before this Court. That being so, we would be able to fashion effective relief to the extent of remanding with instructions to the bankruptcy court to order the return to Frito-Lay of any funds that were erroneously disbursed to such parties, to the extent that can be done manageably and without imperiling LTV's fresh start. See, e.g., In re Spirtos, 992 F.2d 1004, 1007 (9th Cir.1993); In re International Environmental Dynamics, Inc., 718 F.2d 322, 326 (9th Cir.1983). We are not persuaded by LTV's argument that Frito-Lay's appeal is mooted as a result of the bankruptcy court's order that the assets re-vested in LTV are to be held free and clear of all claims and interests. The district court's affirmance of that order is before us on this appeal. 28 The bankruptcy court made no determination (as it might have during its consideration of Frito-Lay's stay application) as to how payment of Frito-Lay's claims might affect LTV's re-emergence as a revitalized entity. Although counsel for LTV has assured a prior panel of this Court that his client would endeavor to pay any judgment to Frito-Lay without relapsing into Chapter 11, this Court is in no position to evaluate or act upon that assurance, nor can LTV's counsel speak for the numerous interests that were represented at the confirmation hearings and that would still suffer if the reorganization failed. Similarly, although reorganized LTV presents itself on appeal as an invigorated multi-billion dollar operation with $200 million in working capital and a $400 million line of credit, we are in no position to determine the effect that granting all of the requested relief would have on parties, such as investors, not before this Court. 29 Nevertheless, a remand is not necessary. Although the bankruptcy court might determine that full relief is no longer available to Frito-Lay after substantial consummation, we are convinced that at least some effective relief could be granted. Certainly, Frito-Lay would readily accept some fractional recovery that does not impair feasibility or affect parties not before this Court, rather than suffer the mootness of its appeal as a whole. Cf. MCI Telecommunications Corp. v. Credit Builders of America, Inc., 2 F.3d 103, 104 (5th Cir.) ([A] case is not mooted by the fact that an impecunious judgment debtor may lack the means to satisfy a judgment. (citations omitted.)), cert. denied, --- U.S. ----, 114 S.Ct. 472, 126 L.Ed.2d 424 (1993). A claimant should not be out of court on grounds of mootness solely because its injury is too great for the debtor to satisfy in full. 30 Also significant is that Frito-Lay sought to stay confirmation of the Plan in urgent applications before the bankruptcy court, the district court and this Court. Frito-Lay did not prevail on any of those applications, but that result certainly cannot be attributed to any lack of initiative. Although we recognize the value of finality in bankruptcy proceedings and the need to afford reorganized LTV a fresh start, those considerations are not sufficient to moot this issue on appeal. 31 5. Debtors' Right to Reject Contracts and Leases. Subject to court approval, a bankruptcy trustee or debtor-in-possession may assume or reject an executory contract or unexpired lease of the debtor. 11 U.S.C. Sec. 365(a) (1988). Claims arising under contracts or leases so assumed are afforded administrative priority. Paragraph 8.1 of the Plan addresses LTV's assumption and rejection of contracts under Bankruptcy Code Section 365: 32 The Debtors assume on and as of the Effective Date pursuant to Section 365 of the Code any and all executory contracts and leases of real estate except those which shall prior to the Confirmation Date have been rejected pursuant to Section 365 of the Code. For such purpose, unsecured Tax Benefit Transfer Agreements shall constitute non-executory contracts. 33 (Emphasis added.) Bearing these factors in mind, Frito-Lay seeks priority by arguing (1) that the Plan assumes all executory contracts that are not expressly rejected, (2) that Frito-Lay's safe-harbor leases are executory contracts, notwithstanding the Plan's categorization of unsecured tax benefit transfer agreements as non-executory, (3) that it is undisputed that LTV never expressly rejected the Frito-Lay leases, and therefore (4) that the Frito-Lay leases must be considered assumed. Frito-Lay also maintains that the safe-harbor leases are unexpired leases under Section 365, but offers no rationale for considering such unexpired leases assumed. 34 In briefing before this Court, the parties hotly contest whether or not the Frito-Lay safe-harbor leases properly can be categorized as executory contracts or unexpired leases; the bankruptcy court found that they are neither. In re Chateaugay Corp., 136 B.R. 79, 83-84 (Bankr.S.D.N.Y.1992); In re Chateaugay Corp., 102 B.R. 335, 350-56 (Bankr.S.D.N.Y.1989). The district court found it unnecessary to resolve the issue, holding that, even if the safe-harbor leases could be considered executory contracts or unexpired leases, the Debtors at no time elected to assume them and, in fact, were not entitled to assume them because Frito-Lay performed no post-petition act that benefited the Debtors. In re Chateaugay Corp., 156 B.R. 391, 399 (S.D.N.Y.1993). Cf. In re Grayson-Robinson Stores, Inc., 321 F.2d 500, 502 (2d Cir.1963) ([I]n making a determination whether or not to reject, the advantages of giving and receiving further performance are to be weighed against the disadvantages.). Hence, both the district court and the bankruptcy court held that Section 365 and Paragraph 8.1 do not confer priority on Frito-Lay's claims. We affirm on grounds similar to those stated by the district court. 35 The main purpose of Section 365 is to allow a debtor to reject executory contracts in order to relieve the estate of burdensome obligations while at the same time providing a means whereby a debtor can force others to continue to do business with it when the bankruptcy filing might otherwise make them reluctant to do so. Richmond Leasing Co. v. Capital Bank, N.A., 762 F.2d 1303, 1310 (5th Cir.1985) (per curiam). The estate's election to assume a contract or lease under Section 365 entitles the other contracting party to assert its claims on a priority basis. Section 365 does not confer any power of election upon the other contracting party. Although LTV never expressly rejected Frito-Lay's safe-harbor leases pursuant to Section 365, LTV never elected (and never secured court approval) to assume those leases, as Paragraph 8.1 of the Plan clearly shows. The Plan was confirmed and is now substantially consummated. We are in no position, were we so inclined, to compel the Debtors to assume the safe-harbor leases nunc pro tunc. 36 Even so, a debtor sometimes may incur priority expenses under an executory contract or unexpired lease, without an express election, if the bankrupt estate derives benefits under that contract. See In re Unishops, Inc., 553 F.2d 305, 308 (2d Cir.1977). Frito-Lay seeks the benefit of this equitable principle by attributing to the safe-harbor leases the post-petition tax benefits that LTV received upon disqualification of the relevant assets. We conclude, however, that LTV received no post-petition benefit under the leases. 37 Two things happened that together resulted in a benefit to LTV: LTV retired certain assets; and that act triggered tax consequences favorable to LTV. Neither event required Frito-Lay to do anything. LTV had full power to dispose of its assets before it signed the leases, and the leases simply acknowledge LTV's retention of that pre-existing power. LTV needed no consent from Frito-Lay to dispose of the qualified assets, and did not use any power conferred by the leases in doing so. The tax benefits that Frito-Lay enjoyed were conferred by the federal Tax Code, and did not spring from any as yet unperformed provision of the leases. Unquestionably, LTV visited a post-petition loss on Frito-Lay, but that is not the same thing as saying that Frito-Lay thereby conferred a contractual benefit on LTV or that a benefit was otherwise conferred on LTV under the leases. Frito-Lay was LTV's victim, but that status is not enough to support an administrative claim. 38 LTV's disqualification of assets resulted in tax benefits to LTV because the federal Tax Code treats disqualification as a repurchase of the asset by the seller/lessee. Frito-Lay argues that this repurchase, by which LTV is deemed to have acquired property from Frito-Lay, should be treated as an administrative claim as would any other post-petition transaction for the sale of business property. Although such a repurchase is deemed to have occurred (under Former Temp. Reg. Secs. 5c.168(f)(8)-8(d)) rather than actually performed, Frito-Lay argues that the repurchase had real ramifications, conferred real benefits on LTV, and cannot be brushed aside as a legal fiction or construct. For example, all of the federal tax ramifications that have been so advantageous to LTV and so disadvantageous to Frito-Lay correspond to the consequences that would ordinarily flow from the repurchase of business property involved in a sale-leaseback transaction. Thus, the sale is real enough within the realm of the Tax Code, and it certainly creates real tax and accounting consequences. However, as we have already stated, the events that brought about the repurchase required no contractual performance by Frito-Lay and stemmed from the disposition of property that LTV at all times owned and had full power to sell or retire. Contrary to Frito-Lay's argument, the indemnification provisions of the safe-harbor leases do not constitute restrictions on LTV's unilateral power to dispose of the assets and do not give to Frito-Lay any interest in the assets; the indemnification clauses were necessitated precisely because the safe-harbor leases imposed no such restrictions on LTV and gave no such interest to Frito-Lay. Therefore, Frito-Lay's nominal resale of the leased assets cannot be said to have conferred the kind of post-petition benefit that will support an administrative priority claim in bankruptcy. 39 By reason of LTV's decision to retire the assets, Frito-Lay became entitled to an indemnification award to be paid on an impaired basis as a general unsecured claim, as the Plan provides. See In re Hemingway Transport, 954 F.2d 1, 8-9 (1st Cir.1992). We therefore affirm the district court's holding that--accepting without deciding that the Frito-Lay/LTV safe-harbor leases are executory contracts or unexpired leases--the debtors-in-possession neither assumed them nor received benefit under them, and that Frito-Lay's indemnification claims are not entitled to administrative priority pursuant to Section 365 and Paragraph 8.1 of the Plan. 40 Finally, Frito-Lay argues that its indemnification claims are entitled to priority as administrative expenses by virtue of Sections 503 and 507 of the Bankruptcy Code, 11 U.S.C. Secs. 503, 507 (1988). It is well settled, however, that a claim will be afforded priority  'only to the extent that the consideration supporting the claimant's right to payment was both supplied to and beneficial to the debtor-in-possession in the operation of the business.'  Trustees of Amalgamated Ins. Fund v. McFarlin's, Inc., 789 F.2d 98, 101 (2d Cir.1986) (quoting In re Mammoth Mart, Inc., 536 F.2d 950, 954 (1st Cir.1976)). We have already determined, however, that the safe-harbor leases were entered into pre-petition and that Frito-Lay provided no post-petition benefit to the debtors-in-possession. Rather, as the district court observed, Frito-Lay's claim for administrative priority boils down to an assertion that the debtors-in-possession took actions in the estate's best interest that left Frito-Lay in the position of being unable to satisfy for 100 cents on the dollar its rights under its pre-petition contracts. That merely subjected Frito-Lay to the kind of unfairness that Chapter 11 evenly distributes among similarly situated creditors. 41 We therefore conclude that LTV was entitled to judgment as a matter of law against Frito-Lay's request for administrative priority made pursuant to Sections 365, 503 and 507 of the Bankruptcy Code. 42