Court Opinion

ID: 2719153
Source: CourtListenerOpinion
Date Created: 2014-08-20 01:00:47.477272+00
Date Added: 2024-06-11T13:26:05.054504
License: Public Domain

FILED
                                                           AUG 19 2014
                                                       SUSAN M. SPRAUL, CLERK
 1                        NO FO PUBL A IO
                            T R     IC T N               U.S. BKCY. APP. PANEL
                                                         OF THE NINTH CIRCUIT
 2
 3                  UNITED STATES BANKRUPTCY APPELLATE PANEL
 4                            OF THE NINTH CIRCUIT
 5   In re:                        )     BAP No.      CC-13-1563-KiTaD
                                   )
 6   GENTILE FAMILY INDUSTRIES,    )     Bk. No.      13-16402-TA
                                   )
 7                  Debtor.        )
                                   )
 8                                 )
     DIATOM, LLC,                  )
 9                                 )
                    Appellant,     )
10                                 )
     v.                            )     M E M O R A N D U M1
11                                 )
     COMMITTEE OF CREDITORS HOLDING)
12   UNSECURED CLAIMS; GENTILE     )
     FAMILY INDUSTRIES,            )
13                                 )
                    Appellees.     )
14   ______________________________)
15                  Argued and Submitted on June 26, 2014,
                            at Pasadena, California
16
                            Filed - August 19, 2014
17
                Appeal from the United States Bankruptcy Court
18                  for the Central District of California
19        Honorable Theodor C. Albert, Bankruptcy Judge, Presiding
20
     Appearances:    David Max Gardner, Esq. of Young Wooldrige LLP
21                   argued for appellant, Diatom, LLC; Jeffrey Wayne
                     Broker, Esq. of Broker & Associates PC argued for
22                   appellee, Gentile Family Industries; Nanette D.
                     Sanders, Esq. of Ringstad & Sanders LLP argued for
23                   appellee, Committee of Creditors Holding Unsecured
                     Claims.
24
25   Before:   KIRSCHER, TAYLOR and DUNN, Bankruptcy Judges.
26
          1
            This disposition is not appropriate for publication.
27   Although it may be cited for whatever persuasive value it may have
     (see Fed. R. App. P. 32.1), it has no precedential value. See 9th
28   Cir. BAP Rule 8013-1.
 1        Creditor Diatom, LLC ("Diatom") appeals an order approving
 2   the motion of chapter 112 debtor Gentile Family Industries ("GFI")
 3   to assume an unexpired nonresidential real property lease.    We
 4   AFFIRM.3
 5              I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY
 6   A.   Events prior to GFI's bankruptcy
 7        GFI's principal business is an open pit diatomaceous earth
 8   mining operation on land leased from Diatom.   Steven Gentile
 9   ("Gentile") is the President of GFI.    GFI pays royalties to Diatom
10   based upon the tonnage of diatomaceous earth mined.   Virtually all
11   of GFI's business comes from the Diatom mining operation.    Diatom
12   is comprised of three members — Mr. and Mrs. Cooper and their son
13   David Cooper.
14        Although GFI had been mining on the Diatom property since
15   2001, the parties did not have a written lease until 2006.    On
16   January 12, 2006, GFI and Diatom executed a Land Use Agreement for
17   Mining Purposes (the "Cooper Lease").   The Cooper Lease had an
18   initial term through December 31, 2010, with the option for
19   additional five year terms:
20        Term. The initial term of the Agreement shall be from
          the date of this Agreement to and including December 31,
21        2010 . . . . The Term shall be for five (5) years with
          the option for additional five (5) year terms as long as
22        all conditions of operation meet the "Owner's" approval
          and both "GFI" and "Owner" agrees [sic] to future use of
23
24
          2
            Unless specified otherwise, all chapter, code and rule
25   references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and
     the Federal Rules of Bankruptcy Procedure, Rules 1001-9037.
26
          3
            GFI filed a motion to supplement the record, which includes
27   several notices of cure payments in connection with its approved
     motion to assume. Because these exhibits have no bearing on our
28   decision in this appeal, we DENY the motion.

                                    -2-
 1        the same surface areas as currently agreed upon, unless
          sooner surrendered or otherwise terminated.
 2
 3        The Cooper Lease expired on December 31, 2010.   Nothing was
 4   expressly communicated between the parties about exercising the
 5   option for another five-year term, but they proceeded with
 6   business as usual for the next thirty months until GFI's
 7   bankruptcy filing in July 2013.    Gentile testified that at all
 8   times subsequent to December 31, 2010, he believed the Cooper
 9   Lease was in its second five-year term.
10        In or around 2012, GFI fell behind on its royalty payments to
11   Diatom.   On July 13, 2013, Diatom served a 30-day notice to cure
12   over $140,000 in royalty arrearages and other various defaults
13   under the Cooper Lease (the "Default Notice").   The Default Notice
14   reminded GFI of its unfulfilled obligations for biannual increases
15   in the royalty rates according to the terms of the Cooper Lease,
16   noting that the lease was "now in its seventh (7) year of life[.]"
17   B.   Postpetition events
18        1.    GFI's motion to assume the Cooper Lease
19        In response to the Default Notice, GFI filed a chapter 11
20   bankruptcy case on July 29, 2013, and timely moved to assume the
21   Cooper Lease under § 365(b)(1)("Motion to Assume").   GFI argued
22   the Cooper Lease was not expired and, thus, was assumable based on
23   the parties' conduct, Diatom's admission in the Default Notice
24   that the Cooper Lease was in its "seventh (7) year of life" and
25   because no written communication existed to suggest the Cooper
26   Lease was anything other than in its first renewal term.   GFI
27   argued that if it was not allowed to assume the lease, it would be
28   forced to close its business and cease operations almost

                                       -3-
 1   immediately, leaving little or no recovery for unsecured
 2   creditors.      The Official Committee of Creditors Holding Unsecured
 3   Claims joined in GFI's motion, contending it would help promote a
 4   successful reorganization and was in the best interest of
 5   creditors.
 6        Diatom opposed the Motion to Assume on two grounds:      (1) GFI
 7   was improperly using the assumption process under § 365 to get a
 8   declaratory ruling that the Cooper Lease's term was something
 9   other than month-to-month;4 and (2) the Cooper Lease was not in
10   the middle of a second five-year term as contended by GFI.      Diatom
11   argued that under CAL. CIV. CODE § 1945, GFI became a month-to-month
12   tenant effective January 1, 2011, because it had not exercised the
13   option to extend the Cooper Lease by an additional five-year term.
14   Relying on the paragraph entitled "Notices," Diatom argued that
15   because GFI did not communicate a renewal in writing, the Cooper
16   Lease was not renewed in January 2011:
17        Notices. All notices and other communications to other
          party shall be given in writing and shall be sufficiently
18        given if (i) delivered in person, (ii) sent by electronic
          communication, with confirmation sent by registered or
19        certified mail, return receipt requested, or (iii) sent
          by registered or certified mail, return receipt requested
20        . . . .
21   Diatom disputed GFI's assertion that the "seventh (7) year of
22   life" comment Mrs. Cooper made in the Default Notice evidenced the
23   parties' agreement the Cooper Lease was in a second five-year
24   term.       Her description simply identified that it had been seven
25   years since the Cooper Lease was executed.
26
             4
            Diatom's objection to the alleged deficient procedural
27   process was stated only in the "Introduction" section of its
     opposing brief and was not supported by any further argument or
28   authority.

                                         -4-
 1          Diatom conceded California case law provides that a tenant's
 2   continued possession of the premises may be a valid exercise of an
 3   option to renew, citing ADV Corp. v. Wikman, 178 Cal.App.3d 61
 4   (1986), but argued that ADV is distinguishable because the option
 5   to renew there was not required to be in writing.     Diatom also
 6   argued that GFI, unlike the tenant in ADV, did not engage in any
 7   conduct prior to the expiration of the original term to indicate
 8   that it intended to extend the Cooper Lease for another five
 9   years.      Attached to Diatom's opposition was a declaration from
10   David Cooper and copies of cases and treatises Diatom argued
11   supported its position that the Cooper Lease was on a month-to-
12   month basis.
13          In reply, GFI argued that the Cooper Lease was silent on the
14   mechanics by which the option to extend for additional five-year
15   terms could be effected and nowhere in the "Term" section, which
16   is the only place where the option is discussed, was there a
17   requirement that exercise of the option be in writing.     GFI argued
18   that California and Ninth Circuit law was clear:     when no writing
19   is required under the terms of the lease to interpret a renewal,
20   the conduct of the parties establishes it.     Thus, GFI's continued
21   possession and the actions of the parties conclusively established
22   the option had been exercised to extend the Cooper Lease for a
23   second five-year term, which was in place for thirty months prior
24   to Diatom’s issuance of Default Notice.
25          2.     The bankruptcy court's ruling on the Motion to Assume
26          At the hearing on the Motion to Assume, counsel for Diatom
27   conceded the Cooper Lease was executory and could be assumed by
28   GFI.    However, Diatom objected to GFI's ability to seek what was

                                        -5-
 1   essentially a declaratory ruling as to the term of the Cooper
 2   Lease.   Notwithstanding that objection, counsel proceeded to argue
 3   the Cooper Lease was only on a month-to-month term due to GFI's
 4   failure to communicate in writing that it was exercising the
 5   option to extend the lease for another five-year term.     The
 6   bankruptcy court agreed that a debtor seeking to assume a lease
 7   cannot change or amend the lease's term.     Nonetheless, it
 8   disagreed with counsel's contention that GFI had to provide
 9   notice, either in writing or otherwise, to extend the Cooper
10   Lease.   Counsel for Diatom conceded that the "Term" section was
11   silent as to whether notice had to be given in order to extend it.
12        After hearing further argument from Diatom that the Cooper
13   Lease was month-to-month, the bankruptcy court stated:
14        I disagree.      I think that continued occupation,
          continuing tendering of rent is probably enough to get
15        them around this argument you have, which just lapsed
          into a month to month. Even your own client didn't treat
16        this as a month to month because they've gone ahead and
          given two years after the fact a written notice, so even
17        they don't think it's a month to month. I don't think
          that cuts much ice.
18
19   Hr'g Tr. (Nov. 6, 2013) 12:20-13:2.
20        The bankruptcy court entered an order approving the Motion to
21   Assume on November 14, 2013.   In addition to the required findings
22   under § 365(b)(1), the court determined that the "Cooper Lease was
23   extended by the conduct of the parties into its first five (5)
24   year option term commencing as of December 30, 2010[.]"     Diatom
25   timely appealed.
26                             II. JURISDICTION
27        The bankruptcy court had jurisdiction under 28 U.S.C. § 1334
28   and § 157(b)(2)(A).   We have jurisdiction under 28 U.S.C. § 158.

                                     -6-
 1                                  III. ISSUE
 2        Did the bankruptcy court err when it determined in the
 3   context of the Motion to Assume the disputed issue of whether the
 4   Cooper Lease had been extended for another five years or whether
 5   its term was month-to-month?
 6                           IV. STANDARD OF REVIEW
 7        Whether the bankruptcy court's procedures comport with due
 8   process is reviewed de novo.    Price v. Lehtinen (In re Lehtinen),
 9   564 F.3d 1052, 1058 (9th Cir. 2009); Garner v. Shier
10   (In re Garner), 246 B.R. 617, 619 (9th Cir. BAP 2000).
11                               V. DISCUSSION
12        The bankruptcy court's decision to determine the term of the
          Cooper Lease in a contested matter rather than requiring an
13        adversary or some other proceeding was harmless error.
14        Diatom contends the bankruptcy court erred by deciding the
15   issue of the Cooper Lease's term in the context of the Motion to
16   Assume, which Diatom contends is a summary proceeding and limited
17   in nature.   Diatom argues the bankruptcy court exceeded the scope
18   of its authority under § 365 when it decided this disputed
19   contract issue, and it requests on appeal the "right to prove,
20   through the appropriate legal procedure, that the lease term is
21   month-to-month under clear California law."      Diatom suggests the
22   issue of the contract term would be best resolved in an unlawful
23   detainer action or an action for declaratory relief.     GFI argues
24   that it was appropriate for the bankruptcy court to inquire into
25   whether the Cooper Lease was unexpired as part of its ruling on
26   the Motion to Assume.
27        Whether to assume or reject an executory contract or
28   unexpired lease is left to the business judgment of the trustee or

                                       -7-
 1   debtor in possession.   Official Creditors Comm. v. X10 Wireless
 2   Tech., Inc. (In re X10 Wireless Tech., Inc.), 2005 WL 6960205, at
 3   *3 (9th Cir. BAP Apr. 5, 2005)(citing Durkin v. Benedor Corp.
 4   (In re G.I. Indus., Inc.), 204 F.3d 1276, 1282 (9th Cir. 2000)).
 5   It is undisputed that only an executory contract or unexpired
 6   lease of the debtor existing at the time of petition is capable of
 7   being assumed; the issue whether the subject contract or lease has
 8   terminated prepetition is determined under state law.     Vanderpark
 9   Props., Inc. v. Buchbinder (In re Windmill Farms, Inc.), 841 F.2d
10   1467, 1469 (9th Cir. 1987); In re Kong, 162 B.R. 86, 91 (Bankr.
11   E.D.N.Y. 1993)(if the contract or lease has expired by its own
12   terms or has been terminated prior to the petition date then
13   nothing exists for debtor to assume or reject); § 365(a).     The
14   bankruptcy court clearly has the authority to determine this
15   threshold issue.   See In re Windmill Farms, Inc., 841 F.2d at
16   1472; In re Kong, 162 B.R. at 91 (before a debtor can seek relief
17   under § 365(a), it must be established that an executory contract
18   or unexpired lease exists at the time of the filing)(citing
19   2 COLLIER ON BANKRUPTCY ¶ 365.02 (Lawrence P. King et al., eds. 15th
20   ed. 1992)).
21        The question of whether the Cooper Lease was "unexpired" was
22   not disputed.   Diatom repeatedly conceded the Cooper Lease was
23   unexpired at the time GFI filed for bankruptcy and that it was
24   capable of being assumed.   What Diatom disputes is whether the
25   bankruptcy court could determine the disputed lease term in the
26   context of the Motion to Assume.
27        Diatom relies on Orion Pictures Corp. v. Showtime Networks,
28   Inc. (In re Orion Pictures Corp.), 4 F.3d 1095, 1098 (2d Cir.

                                      -8-
 1   1993), to support its position that the bankruptcy court could not
 2   decide this issue in the context of the Motion to Assume.    In
 3   Orion, the debtor entered into a prepetition contract with
 4   Showtime.    Showtime contended Orion breached the contract and
 5   could not assume it.   Orion moved to assume the contract under
 6   § 365 and simultaneously filed an adversary proceeding against
 7   Showtime claiming anticipatory breach.   The bankruptcy court tried
 8   the breach issue in connection with the assumption motion.
 9   Determining that Orion had not breached, the court authorized the
10   assumption and dismissed the related adversary proceeding as moot.
11   The district court affirmed.
12        In reversing, the Second Circuit held § 365 did not authorize
13   bankruptcy courts to resolve questions involving the validity of
14   contracts in the context of assumption motions.   "[I]t was error
15   for the bankruptcy court to decide a disputed factual issue
16   between the parties to a contract in the context of determining
17   whether the debtor or trustee should be permitted to assume that
18   contract."   Id. at 1098.   "At heart, a motion to assume should be
19   considered a summary proceeding, intended to efficiently review
20   the trustee's or debtor's decision to adhere to or reject a
21   particular contract in the course of the swift administration of
22   the bankruptcy estate.   It is not the time or place for prolonged
23   discovery or a lengthy trial with disputed issues."   Id. at
24   1098-99.
25        Although not cited by the parties, the Ninth Circuit adopted
26   the reasoning of Orion in In re G.I. Indus., Inc., 204 F.3d at
27   1282.   There, a creditor had sued debtor for breach of contract in
28   state court prepetition.    Shortly thereafter, debtor filed a

                                      -9-
 1   chapter 11 bankruptcy case and attempted to remove the action to
 2   the bankruptcy court.   After that failed, the trustee moved to
 3   reject the parties' contract.    The bankruptcy court agreed the
 4   contract was burdensome; the rejection was within the sound
 5   business judgment of the trustee.    Based on the rejection, the
 6   creditor filed a proof of claim for damages under § 365(g).      The
 7   trustee objected to the proof of claim.    As a result, the
 8   bankruptcy court held a five-day trial inquiring into the validity
 9   of the contract.   The court ultimately disallowed the creditor's
10   claim, finding that the contract was unenforceable due to a lack
11   of mutual intent between the parties and a lack of consideration.
12   The district court affirmed.    Id. at 1279-80.
13        On appeal, the creditor contended the trustee's rejection of
14   the contract conclusively established a statutory breach of
15   contract that precluded the bankruptcy court from inquiring into
16   the validity of the underlying contract.    Id. at 1280.   The Ninth
17   Circuit disagreed, holding the bankruptcy court could properly
18   examine the validity of a rejected contract during the claims
19   process based on the plain language of § 502(b)(1).    However,
20   relying on Orion, it went on to hold:
21        Based on the nature of a motion to reject and its
          complementary proceedings, it is inappropriate for the
22        court to resolve questions involving the validity of a
          contract at the time of rejection. As the Second Circuit
23        noted in Orion Pictures Corp. v. Showtime Networks, Inc.
          (In re Orion Pictures Corp.), 4 F.3d 1095 (2d Cir. 1993),
24        "permitting a bankruptcy court to rule conclusively on a
          decisive issue of breach of contract would render the use
25        of ‘business judgment' . . . unnecessary." Id. at 1099.
          Orion correctly recognizes that adjudicating the validity
26        of a contract at the time of rejection would turn a
          summary proceeding into a full trial on the merits, a
27        result that would be inconsistent with the procedures
          found in the Bankruptcy Code.      Instead, our approach
28        gives effect to the plain language of the Bankruptcy Code

                                      -10-
 1        and allows a bankruptcy judge to postpone consideration
          of the validity of a contract until a full adversary
 2        proceeding can take place. This approach better conforms
          with the structure of the code.
 3
 4   Id. at 1282.    In other words, the validity of a contract, if
 5   disputed, cannot be determined in the context of a motion to
 6   assume or reject.   An adversary proceeding is required.
 7        Whether a determination as to the "term" of an unexpired
 8   lease is a determination on the "validity" of a contract for
 9   purposes of § 365 is not clear.    The Ninth Circuit has not defined
10   exactly what falls into the "validity" category.    Certainly,
11   Diatom and GFI never questioned the Cooper Lease's "validity."
12   However, taking a broad view of G.I. Indus., Inc., it may be that
13   an adversary proceeding was required for the bankruptcy court to
14   determine the term of the Cooper Lease.   We need not decide that
15   issue, however, because for all practical purposes an adversary
16   proceeding was held in this case.
17        Diatom characterized the relief GFI sought as to the Cooper
18   Lease's term as an action for declaratory relief.   Generally, an
19   adversary proceeding is required for a declaratory judgment under
20   Rule 7001(9).
21        It is error to circumvent the requirement of an
          adversary proceeding by using a 'contested matter'
22        motion under Rule 9014.[5] Such an error may
          nevertheless be harmless when the record of the
23        procedurally incorrect 'contested matter' is developed
          to a sufficient degree that the record of an adversary
24        proceeding likely would not have been materially
          different.
25
26   Ruvacalba v. Munoz (In re Munoz), 287 B.R. 546, 551 (9th Cir. BAP
27
          5
            Under Rule 6006, a proceeding to assume, reject or assign
28   an executory contract or unexpired lease is governed by Rule 9014.

                                       -11-
 1   2002); Trust Corp. of Mont., Inc. v. Patterson (In re Copper King
 2   Inn, Inc.), 918 F.2d 1404, 1407 (9th Cir. 1990)(where the record
 3   shows the parties received adequate notice concerning the nature
 4   of the issues raised in a contested motion proceeding, extensive
 5   hearings occurred, briefing was submitted and the parties were
 6   given ample time to air their position; for all practical purposes
 7   an adversary proceeding was held).      See also Korneff v. Downey
 8   Reg'l Med. Ctr. Hosp., Inc. (In re Downey Reg'l Med. Ctr. Hosp.,
 9   Inc.), 441 B.R. 120, 127 (9th Cir. BAP 2010) (bankruptcy court's
10   decision not to require an adversary proceeding is subject to a
11   harmless error analysis).   "In such circumstances, the error does
12   not affect the substantial rights of the parties and is not
13   inconsistent with substantial justice."     In re Munoz, 287 B.R. at
14   551.    See, e.g., 28 U.S.C. § 2111; Rule 9005; In re Copper King
15   Inn, Inc., 918 F.2d at 1406-07; Laskin v. First Nat'l Bank
16   (In re Laskin), 222 B.R. 872, 874 (9th Cir. BAP 1998); United
17   States v. Valley Nat'l Bank (In re Decker), 199 B.R. 684, 689–90
18   (9th Cir. BAP 1996).
19          Even if the bankruptcy court possibly erred in not requiring
20   an adversary proceeding to determine the Cooper Lease's term, we
21   conclude that such error was harmless.     GFI was clear in its
22   Motion to Assume what relief it was seeking and on what basis; it
23   contended the Cooper Lease was in the middle of another five-year
24   term.   Diatom had the opportunity to comprehensively brief the
25   issues and did so by filing its opposition, which included a
26   declaration from David Cooper and copies of cases supporting its
27   position that the term was month-to-month.     Notably, while Diatom
28   objected to the bankruptcy court determining the disputed term

                                      -12-
 1   issue in the context of the Motion to Assume, it has never fully
 2   briefed its objection until now.    Plus, Diatom never requested a
 3   continuance of the hearing on the Motion to Assume.       The hearing
 4   was held as scheduled; the parties had ample time to air their
 5   positions.    After considering the parties' evidence and arguments,
 6   the bankruptcy court determined, as a matter of law, that the
 7   Cooper Lease term had been extended another five years.
 8        On this record, we have difficultly understanding how Diatom
 9   was procedurally disadvantaged by the bankruptcy court's approach.
10   We fail to see, particularly since the material facts were few and
11   undisputed and the issue before the court was purely one of law,
12   how an adversary (or some other) proceeding would have produced a
13   materially different result.    Diatom did not convince us otherwise
14   in its appeal brief or at oral argument.    Absent a credible
15   argument or specific examples from Diatom showing it suffered some
16   procedural disadvantage as a result of the bankruptcy court's
17   procedure, the court allowing the matter to proceed as a contested
18   motion rather than an adversary proceeding is not a sufficient
19   reason to disturb the assumption order.    Had the bankruptcy court
20   determined the lease term issue in Diatom's favor, this matter
21   would likely not be before us.
22        Accordingly, even if the bankruptcy court erred in not
23   requiring an adversary proceeding to determine the term of the
24   Cooper Lease, such error did not affect the substantial rights of
25   the parties, is not inconsistent with substantial justice and was
26   therefore harmless.    In re Munoz, 287 B.R. at 551.6
27
          6
              Diatom does not contest the bankruptcy court's
28                                                               continue...

                                      -13-
 1                            VI. CONCLUSION
 2       For the foregoing reasons, we AFFIRM.
 3
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26       6
           ...continue
     determination that the Cooper Lease had been extended for an
27   additional five-year term, only that it erred in making that
     determination in the context of the Motion to Assume. Therefore,
28   we do not address the merits of the bankruptcy court's decision.

                                   -14-