Appeal from order of United States District Court for the District of Connecticut, M. Joseph Blumenfeld, J., affirming order of bankruptcy judge Seidman permitting debtor's Chapter XII trustee to reject certain lease covenants.
Before Waterman, Feinberg and Mansfield, Circuit Judges.
Control Data Corporation, lessee of space in an office building owned by James Minges, the debtor in a Chapter XII proceeding, appeals from an order of the United States District Court for the District of Connecticut, M. Joseph Blumenfeld, J., permitting appellee Steven Zelman, the debtor's Chapter XII trustee, to reject certain covenants in the lease. The order of the district court affirmed an order of bankruptcy judge Saul Seidman. For reasons set forth below, we remand the case for further findings.
So far as we can tell from the somewhat sketchy record before us, the following facts appear to be undisputed. Control Data Corporation, which we shall refer to as the lessee, is the successor in interest of Service Bureau Corporation, the original signatory to the lease with Minges for second floor office space in an office complex called Pro Park in Farmington, Connecticut. The lease provided for a 10-year term, commencing December 1, 1967, with an option in the tenant to extend in successive two-year terms for up to 10 more years. Under the lease, the landlord is obligated to furnish hot and cold water, heat, air-conditioning (including the necessary electricity) and janitorial services. The tenant pays utility charges only for lighting its office premises and for the office machines. These charges are separately metered and billed directly to the tenant by the utility company. The lease also gives the tenant a right of first refusal of all other space in the same building and the right to require the landlord to provide up to 16,000 square feet of additional space. The lessee uses the premises 24 hours a day, every day of the year, as a computer facility and service bureau operation. The lease also provides that it is subordinate to any mortgage but that the mortgage shall contain provisions that the mortgagee, in the event of foreclosure "will not attempt to terminate this lease . . . nor interfere with the rights of" the lessee, if the latter is not in default.
In October 1972, Capital for Technology Corporation (CTC) made a loan to Minges, which was secured by a second mortgage on Pro Park. CTC's parent, Hartford National Bank, also obtained a third mortgage on the property. A year later, CTC paid the arrearages on the first mortgage and exercised its right to take possession of Pro Park. CTC then began a foreclosure action in the state courts and obtained a judgment. Execution of that judgment, however, was stayed after Minges filed his Chapter XII petition in October 1974. The bankruptcy court has allowed CTC to remain as mortgagee in possession of Pro Park, managing the property and collecting the rents.
In September 1976, the Chapter XII trustee petitioned the bankruptcy court to allow him to reject certain portions of the lease as burdensome pursuant to section 413(1) of the Bankruptcy Act. These are the provisions that require the landlord to provide utilities and janitorial service, that grant the tenant the right of first refusal on space in the building that becomes vacant, and that allow the tenant to extend the lease on the original space for five additional two-year terms. According to the bankruptcy judge, there was evidence at the hearing that the value of the space rented under the lease has increased considerably since 1967 from $4.30 per square foot, the lease rate, to "$7.00 per foot or more." The bankruptcy judge also found that in 1967 a reasonably prudent landlord would have expected to spend each year about $7,000 on electricity and $3,000-$4,000 on janitorial service. In contrast, the landlord's annual cost of supplying these services to the lessee in 1975 was approximately.$19,000 and $15,250 a year respectively.
After the hearing, the bankruptcy judge in a lengthy opinion granted the trustee's petition to reject the landlord's covenants to supply utilities and janitorial service as well as the tenant's right to additional space, but denied the petition with regard to the tenant's options to extend the term of the lease. Judge Blumenfeld, in a brief opinion, affirmed the decision of the bankruptcy judge. The trustee has not appealed from the portion of the ruling that was adverse to him, and the lessee apparently does not contest in this court the trustee's rejection of the lessee's right to first refusal on additional space. This appeal, therefore, concerns the trustee's rejection of the landlord's covenants to supply utilities and janitorial service.
Appellant lessee argues to us that the bankruptcy judge applied the wrong legal standards in deciding whether to grant the relief sought by the trustee. Thus, appellant argues that to justify rejection of the lease, or any part of it, the trustee had to show that the lease caused a net loss to the estate rather than merely insufficient profits, that rejection will serve the purpose of Chapter XII, and that rejection will benefit creditors other than CTC and its parent, which are secured by mortgages. None of these conditions, appellant says, was met.
Before assessing these arguments, the statutory scheme must be briefly reviewed. In proceedings initiated under various chapters of the Bankruptcy Act, the bankruptcy court may allow the trustee or debtor in possession to reject executory contracts of the debtor. Thus, the trustee or debtor, in the proper circumstances, may cancel pre-bankruptcy executory contracts of the debtor that are burdensome. See Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn.L.Rev. 439, 447-50 (1973). When such rejection occurs, the other party to the rejected contract becomes a general creditor of the estate for any damages flowing from the rejection. See section 63a(9), c. See also 3A Collier on Bankruptcy PP 63.31, 63.35 (1975).*fn1
Turning specifically to Chapter XII provisions, section 413(1) of the Act provides:
Upon the filing of a petition, the court may, in addition to the jurisdiction, powers, and duties hereinabove and elsewhere in this chapter conferred and imposed upon it
(1) permit the rejection of executory contracts of the debtor, upon notice to the parties to such contracts and to such other parties in ...