The following is a case update written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest:

The Eleventh Circuit Court of Appeals holds that if a trustee does not assume a personal property lease before confirmation of a Chapter 13 plan, the leased property is no longer property of the estate and cannot be assumed by the debtor in the confirmed plan on behalf of the estate. In re Cumbess, 2020 WL 2897260 (June 3, 2020).

To read to full opinion, click here.

FACTS

In 2015, Paul Cumbess (Debtor) entered into a personal property lease (“Lease”) with Microf, LLC, for a heating, ventilation, and air conditioning (“HVAC”) system installed at his residence. Two years later, he filed for bankruptcy in the Middle District of Georgia, under Chapter 13. In his Chapter 13 plan, Debtor provided for prorated payments by the trustee of prepetition obligations to Microf. The plan further assumed the Lease but stated that Debtor would be the “disbursing agent” for future Lease payments. Debtor’s Chapter 13 trustee never assumed or rejected the Lease.

After his plan was confirmed, Debtor repeatedly failed to pay his monthly obligations to Microf. By July 2018, when the balance owed reached $1,763.95 [sic], the lessor could stand no more and filed a motion asking the court to deem the missed payments “necessary costs and expenses of preserving the estate,” which would render them administrative priority expenses under 11 U.S.C. section 503(b)(1)(A). This would have placed the post-petition Lease obligations in second-place priority among all plan obligations, per Section 507(a)(2).

The trustee objected, arguing that the missed Lease payments were not “necessary costs and expenses of preserving the estate” and therefore did not qualify as administrative expenses. Rather, the trustee argued that Debtor alone was responsible for the Lease obligations, which could not be satisfied from estate assets despite the Lease being assumed under the plan.

Though not all courts agree, as a general proposition a non-breaching party to an executory lease or contract in a Chapter 13 case may assert an administrative claim without proving a benefit to the estate in a case where the debtor had assumed but subsequently defaulted on the lease or contract. See In re Parmenter, 527 F.3d 606, 611 (6th Cir. 2008), dissent; In re Ruiz, 2012 WL 5305741, *2 (Bankr. S.D. Fla. 2012).

Nevertheless, the bankruptcy court overruled Microf’s motion, holding that an administrative claim did not arise automatically upon Debtor’s default on his plan obligation. It reached this conclusion by relying on Section 365(p)(1), which states that,

If a lease of personal property is rejected or not timely assumed by the trustee under subsection (d), the leased property is no longer property of the estate . . . .

Because the trustee had not assumed the Lease, the court concluded that the Lease was no longer part of the Debtor’s estate when his plan was confirmed and any benefit the HVAC provided to the Debtor post plan confirmation was not a benefit to the estate. The bankruptcy court further found that Microf failed to establish that the Lease obligations were “necessary costs and expenses of preserving the estate.”

The district court affirmed, holding that Section 365(p)(1) vests a “trustee—not the debtor—with the sole power to obligate the bankruptcy estate on an unexpired lease in chapter 13 cases.” Because the trustee did not assume the Lease, it was no longer an estate asset on the day the plan was confirmed. As Microf’s administrative claim depended on a finding that the Lease remained an estate asset, the motion was properly denied.

Microf appealed to the Eleventh Circuit Court of Appeals, which affirmed the lower courts.

REASONING

The Court of Appeals summed up its ruling succinctly, “Stripped to its bare essence, this bankruptcy appeal presents the question whether the word ‘trustee’ means ‘trustee.’ We hold that it does.” To the Court, “[t]he real question here is whether by assuming the lease as part of his Chapter 13 plan, the debtor can—singlehandedly and, in particular, without any action by the trustee—obligate the bankruptcy estate.”

After a short primer on bankruptcy law, the Court focused on Section 1322(b)(7), which states in relevant part,

(b) Subject to subsections (a) and (c) of this section, the plan may—

(7) subject to section 365 of this title, provide for the assumption, rejection, or assignment of any executory contract or unexpired lease of the debtor not previously rejected under such section.

11 U.S.C. § 1322(b)(7) (emphasis added).

The Court conceded that, under Section 1322(b)(7), a debtor may assume an executory contract or unexpired lease subject to Section 365. But it further found that Section 1322(b)(7) does not specifically authorize the debtor to do so unilaterally, namely without the trustee also assuming the lease. The Court therefore dissected Section 365, concluding that trustees play key roles in lease assumptions. Section 365(a) states that a trustee, “may assume or reject any executory contract or unexpired lease of the debtor.” Moreover Section 365(d)(2) states that,

In a case under [Chapter 13], the trustee may assume or reject an executory contract or unexpired lease of residential real property or of personal property of the debtor at any time before the confirmation of a plan but the court, on the request of any party to such contract or lease, may order the trustee to determine within a specified period of time whether to assume or reject such contract or lease. (Emphasis added.)

Juxtaposing Sections 1322(b)(7), 365(d)(2) and (p)(1), the Court concluded,

Section 365(p)(1)’s plain language answers the question that we are principally tasked with deciding: Where (as here) the trustee does not assume an unexpired lease, it drops out of the estate.

Done and done.

Turning to the lessor’s brief, the Court discussed and rejected the lessor’s diverse arguments, including that the reference to “trustee” in Section 365(p)(1) was interchangeable with the word “debtor”. It acknowledged Section 365(p)(3), which states that,

In a case . . . under chapter 13, if the debtor is the lessee with respect to personal property and the lease is not assumed in the plan confirmed by the court, the lease is deemed rejected as of the conclusion of the hearing on confirmation. . . .

Relying on statutory interpretation maxims, the Court rejected Microf’s argument that, if a lease is rejected because it was not assumed in the plan, it must also mean that “so long as the lease is assumed in the plan, it remains part of the estate.” Rather, it found that Section 365(p)(1) governs a trustee’s authority to assume a lease on the estate’s behalf, while Section 365(p)(3) governs the debtor’s right to assume the lease on his own behalf.

The Court further rejected concerns that this decision will upend longstanding bankruptcy law and practice even while acknowledging that some commentators appear to agree with Microf’s position, including Collier on Bankruptcy. It resignedly concluded,

But even if it didn’t make good sense to us—even if we thought it inefficient to require a Chapter 13 trustee to affirmatively assume an unexpired lease as a precondition to obligating the estate—it wouldn’t much matter. In the end, our job isn’t to decide which reading of § 365(p)(1) produces the best bankruptcy-law system; rather, our job is to determine what the text of § 365(p)(1) requires.

Author’s Comments

It is not clear that the Cumbess decision is either correct or desirable. If adopted by other circuits, it could result in significant changes in Chapter 13 practice.

According to the Court, only a Chapter 13 trustee can bind the bankruptcy estate by assuming or rejecting executory contracts or unexpired leases. This result contradicts Section 1322(b)(7), which states that, subject to Section 365, a plan may assume or reject an executory contract or unexpired lease that has not previously been rejected. Section 365 contains conditions a trustee must comply with to assume or reject an executory contract or unexpired lease. These conditions were likely the reason Congress incorporated Section 365 into the Chapter 13 assumptions and rejections requirements.

While Section 365(p)(1) indeed states that, if a lease of personal property is rejected or not timely assumed “by the trustee” under Subsection (d), the “leased property is no longer property of the estate,” it is not a fortiori clear that this language supports the Cumbess Court’s ultimate ruling.

Section 365(d)(2) states that a Chapter 13 trustee may assume or reject an executory contract or unexpired lease “at any time before the confirmation of a plan,” which means that the property is part of the estate until a plan is confirmed. Conversely, the plan, which can only be filed by a debtor (Section 1321), may also assume or reject an executory contract or unexpired lease. To give meaning to these two seemingly contradictory sections, a trustee must be given the authority to assume or reject an executory contract or unexpired lease until that authority has been supplanted by a confirmed Chapter 13 plan proposed by the debtor. Had Congress intended the result advocated by the Cumbess Court, it could have stated in Section 365(b)(7), “if previously assumed by the Chapter 13 trustee, a Chapter 13 plan may include an executory contract or unexpired lease,” instead of authorizing Chapter 13 plans to assume or reject contracts and leases.

The Cumbess Court acknowledged Section 365(p)(3), which states that,

. . . in a case under chapter 13, if the debtor is the lessee with respect to personal property and the lease is not assumed in the plan confirmed by the court, the lease is deemed rejected as of the conclusion of the hearing on confirmation. If the lease is rejected, the stay under section 362 and any stay under section 1301 is automatically terminated with respect to the property subject to the lease. (Emphasis added.)

Query whether this language would have meaning if a lease were no longer part of the estate when the plan was confirmed unless it was previously assumed by the trustee. The Court tried to reconcile subsections 365(p)(1) and (p)(3) by referring to In re Ruiz, 2012 WL 5305741 at *3 n. 5 (Bankr. S.D. Fla., Feb. 15, 2012), which opined that “[t]he only logical interpretation of [the two subsections] is that the chapter 13 debtor has a right to assume an executory contract separate from the estate’s rights and obligations—similar to reaffirmation in chapter 7.”

However, the Court offers no legal support for the proposition that certain contracts or leases assumed in a plan can be deemed personal debtor obligations while others obligate the estate. Moreover, reaffirmations in Chapter 13 are governed by Section 524(c). It is doubtful Congress intended to create a duplicative reaffirmation process pursuant to Chapter 13 plans without specifically expressing such intent.

In short, it appears that the Cumbess decision may not be the end of the debate on whether a debtor has the authority to unilaterally assume or reject an executory contract or unexpired lease pursuant to a Chapter 13 plan. As recognized by the Cumbess Court, not all commentators agree with this decision. See Collier on Bankruptcy ¶ 1322.11 (Richard Levin & Henry J. Sommer eds., 16th ed. 2020) (“Ordinarily, the chapter 13 debtor exercises the estate’s power to assume or reject a lease through a provision in the chapter 13 plan, which only a debtor may file.”)

Until this issue is resolved by more courts or, ultimately, the United States Supreme Court, the takeaway for practitioners and debtors alike may be that they should ask the Chapter 13 trustee to assume any executory contract or unexpired lease that a debtor wishes to assume under a Chapter 13 plan. If the trustee refuses, lessors should be aware of the risks of a post-confirmation default.

These materials were written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the representative from the Business Law Section (BLS) to the CLA’s Board of Representatives. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.