DeLawrence Beard v. S/E Joint Venture

ON MOTION FOR RECONSIDERATION RODOWSKY, Judge. Respondents have moved that this Court reconsider its opinion filed November 13, 1990. See Beard v. S/E Joint Venture, 321 Md. 126 , 581 A.2d 1275 (1990). Applying Maryland law we held that, in the event the circuit court on remand determined that the Beards would have been awarded specific performance but for the bankruptcy rejection of the executory contract, the circuit court, for the purpose of computing an award of damages in lieu of specific performance, should value the property as of the date specific performance became unavailable.

We said that date was June 17, 1988, when the order of rejection was entered. By their motion Respondents, for the first time in this Court, argue that such an application of Maryland law would be preempted by § 365(g)(1) of the Bankruptcy Code, 11 U.S.C. § 365 (g)(1) (1988). Respondents assert that § 365(g)(1) requires damages in lieu of specific performance to be computed by valuing the realty as of the day preceding the filing of the petition in bankruptcy. The Beards deny that § 365(g)(1) has that effect.

They maintain that § 365(g)(1) simply prevents claims arising out of the rejec ²²⁷ tion of executory contracts from becoming administration expenses, and that the section requires purchasers’ claims, once determined and to the extent unsecured, to be treated ratably with general, unsecured pre-bankruptcy creditors. The background of this issue is as follows. Bankruptcy Judge Mannes in the United States Bankruptcy Court for the District of Maryland on December 10, 1987, lifted the automatic stay under the Bankruptcy Code “to permit [this action] to proceed to trial” in the Circuit Court for Montgomery County. By an order entered on June 17, 1988, Bankruptcy Judge Derby approved S/E Joint Venture’s motion to reject its contract with the Beards.

Bankruptcy Judge Derby further ordered that the Beards “shall, and are authorized to, file any claim they, or either of them, may seek to assert for damages resulting from such rejection on or before thirty (30) days after the entry of this Order.” Presumably the claim was filed. In connection with the motion for reconsideration pending before this Court, we were for the first time furnished a copy of an opinion and order by Judge Derby, entered February 6, 1989. That opinion reflects that, after the circuit court had entered judgment in the amount of $124,-594 for the Beards, representing restitutionary and reliance interest damages, S/E Joint Venture had sought in the bankruptcy court a summary judgment limiting the Beards’ claim to that amount. On the rationale set forth below, Judge Derby denied summary judgment. “[T]he Beards contend that because Debtor’s rejection of their contract deprived them of their option under State law to seek specific performance and forced them to seek damages exclusively, they are entitled to receive under 11 U.S.C. § 365 (g)(1) the monetary equivalent of their specific performance remedy, namely, the loss of the economic benefit of their bargain.

Inherent in this argument as presented by the claimants, on the undisputed facts of this case, is the legal contention that 11 U.S.C. § 365 (g)(1) gives rise to a measure of damages independent of State law. This Court disagrees. ²²⁸ “Section 365(g)(1) provides that ‘... the rejection of an executory contract ... of the debtor constitutes a breach of such contract ... immediately before the date of the filing of the petition----’ The significance under the Bankruptcy Code of treating the breach as occurring immediately prepetition is that the damages arising from the breach are unsecured prepetition claims, rather than post-petition, priority administrative claims. Since the damages are determined as if there was a breach of the contract immediately prepetition, they are measured under State law for breach of contract. E.g., In re Waldron, 36 B.R. 633 (Bkrtcy.S.D.Fla.1984), particularly at 641-42.

Cf., In re Northrup-Johnson, Inc., 15 B.R. 767 (Bkrtcy.D.Md.1981). Section 365(g)(1) does not provide a measure of damages, nor does it prescribe what elements of potential damage are compensable as the result of a breach. These are questions governed by State contract law.” In re S/E Joint Venture, Debtor, Ch. 11 Case No. 87-4-2841SD, Memorandum of Decision at 3-4 (Bankr.D.Md. Feb. 6, 1989). Judge Derby then considered an argument by the debtor that there was no contract in existence to be breached post-petition because of the circuit court’s finding of a breach on March 16, 1987.

The argument was rejected. The bankruptcy court pointed out that the Beards were seeking specific performance in the state court, but that that remedy “was no longer available because Debtor successfully had exercised its legal option to reject the contract. ... The Beards may have alternative bases for computing their damage claim under State law, namely, breach by rejection or prior breach, but they will not receive a double recovery.” Id. at 4-5. In concluding the memorandum decision, Judge Derby said: “Therefore, it appears that if Debtor was able to perform the contract with the Beards, but refused to perform the contract by rejecting it in this bankruptcy case, the Beards allowed claim determined under Maryland law ²²⁹ may include loss of bargain damages as of the date of the breach, namely, immediately before the petition. 11 U.S.C. Section 365 (g)(1).” Id. at 8 .

The circuit court, however, had “made no determination on the rejection damage issue.” Id. at 9 . Section 365, a companion provision of the Bankruptcy Code, § 502(g), and the legislative history of both sections support the Beards’ analysis. Section 365(a) authorizes a trustee in bankruptcy, with court approval, to “assume or reject any executory contract or unexpired lease of the debtor.” Section 365(g) provides in relevant part as follows: “[T]he rejection of an executory contract or unexpired lease of the debtor constitutes a breach of such contract or lease— (1) if such contract or lease has not been assumed under this section or under a plan confirmed under chapter 9, 11, 12, or 13 of this title, immediately before the date of the filing of the petition[.]” Senate Report No. 989, 95th Cong., 2d Sess. 60, reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5846, stated: “Subsection (g) defines the time as of which a rejection of an executory contract or unexpired lease constitutes a breach of the contract or lease. Generally, the breach is as of the date immediately preceding the date of the petition.

The purpose is to treat rejection claims as prepetition claims.” Section 502 of the Code deals with the allowance of claims. Subsection (g) of § 502 reads: “A claim arising from the rejection, under section 365 of this title or under a plan under chapter 9, 11, 12, or 13 of this title, of an executory contract or unexpired lease of the debtor that has not been assumed shall be determined, and shall be allowed under subsection (a), (b), or (c) of this section or disallowed under subsection (d) or (e) ²³⁰ of this section, the same as if such claim had arisen before the date of the filing of the petition.” Senate Report No. 95-989 advises that “[sjubsection (g) gives entities injured by the rejection of an executory contract ... a prepetition claim for any resulting damages, and requires that the injured entity be treated as a prepetition creditor with respect to that claim.” . Senate Report No. 989, 95th Cong., 2d Sess. 65, reprinted in 1978 U.S.Code Cong. & Admin.News, at 5851. The commentators are in general accord with the statements of the Senate Report.

See 2 Collier on Bankruptcy § 365.08, at 365-52 and -53 (L.King 15th ed. 1990) (“Where the contract or lease has not been previously assumed, rejection constitutes a breach immediately before the date of the filing of the petition. The purpose of this is to make clear that, under the doctrine of relation back, the other party to a contract which has not been assumed is simply a general unsecured creditor.” (Footnotes omitted)); 3 Collier on Bankruptcy § 502.07 (L. King 15th ed.1990); 1 W. Drake, Jr., Bankruptcy Practice for the General Practitioner § 9.05 (2d ed.1990). Andrew, Executory Contracts in Bankruptcy: Understanding “Rejection, ” 59 U.Colo.L.Rev. 845 (1988) (Andrew), succinctly states: “The assume-or-reject election created by the courts and carried forward into the Bankruptcy Code has a clear and fairly modest purpose: to insure that creditors of the debtor who are parties to pending contracts and leases do not become administrative creditors of the estate merely by virtue of the estate’s succession to the debtor’s property. The doctrine achieves that goal in simple (though indirect) fashion, by deeming that contract and lease assets do not pass into the estate absent an affirmative decision to accept them; the cost of acceptance is an assumption of the liabilities they entail. ‘Rejection,’ at least in the context of the basic assume-or-reject election, is nothing more than the label for the election not to assume a contract or lease.” ²³¹ Id. at 866.

With respect to the rejection-as-breach rule, Andrew concludes: “When an executory contract or lease is not assumed by the estate, the ‘breach’ rule simply coordinates the treatment of the non-debtor party with that of all other creditors by creating a presumption, conclusive for claims allowance purposes, that the debtor will not perform. The ‘breach’ rule thus is not in any sense designed to diminish the non-debtor’s rights vis-a-vis the estate, but rather to buttress them. Relief to the debtor is correspondingly enhanced, because the debtor’s obligation on the contract will be within the scope of discharge.” Id. at 877-78. 1 In their memoranda supporting and opposing the motion for reconsideration that is before us, the parties have not cited any decision that analyzes the interrelationship between § 365(g)(1) of the Code and a rule of state law which awards damages in lieu of specific performance by valuing realty as of the time specific performance becomes unavailable. There are, however, decisions involving facts analogous to those presented here.

Guidance from those cases points in different directions. Supporting the Beards’ position is In re Waldron, 36 B.R. 633 (Bankr.S.D.Fla.1984), rev’d on other grounds, 785 F.2d 936 (11th Cir.1986), cert. denied, 478 U.S. 1028 , 106 S.Ct. 3343 , 92 L.Ed.2d 763 (1986). Waldron, 36 B.R. at 641-42 , was cited by Judge Derby for the proposition that the amount of a creditor’s claim for rejection damages is determined in accordance with state law. In Waldron the debtors on January 15, 1964, gave the creditor an option to purchase land, exercisable during the period January 1, 1984, through December 31, 1994.

The bankruptcy court permitted the debtors to reject the option contract and ²³² turned to the measure of damages under Florida law. The court held that the optionee-creditor was “entitled to the ‘benefit of the bargain;’ that is, the difference between the estimated market value of the property at the time the option becomes exercisable on January 1, 1984, less the option agreement price, plus an additional speculative premium, if any, reflecting anticipated appreciation of the value of the property at the time the option will lapse on December 31, 1994, as well as any additional loss suffered by [the optionee] as the natural and proximate result of the breach.” 36 B.R. at 642 . If Respondents’ contention to us were correct, § 365(g)(1) should have compelled the Waldron option to be valued by valuing the property subject to the option as of the day immediately preceding the petition. That petition date in Waldron was prior to the date the option became exercisable.

Further contrary to Respondents’ construction of § 365(g)(1) is that the Waldron court permitted consideration of the anticipated appreciation of the property at the end of the decade over which the option was