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Good News for Equipment Lessors – Priority for Idle Equipment!

By: Peter C. Califano, Esq.

 

GOOD NEWS FOR EQUIPMENT LESSORS – PRIORITY FOR IDLE EQUIPMENT

In March 2018, the United States District Court for the Western District of Louisiana[1] affirmed a Bankruptcy Court’s order allowing an administrative expense claim for leased equipment that sat idle and unused for the initial 60-day period after the debtor-lessee filed a Chapter 11 bankruptcy case.  This was a good decision for equipment lessors and may signal that another Circuit Court (Fifth) is ready to further expand the allowance and priority of unpaid rent claims for lessors of personal property leases.

FACTS

On October 16, 2015 Kimzey Casing Service, LLC filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code.  One of the Debtor’s creditors was Premium Casing Equipment, LLC (Premium) which leased specialized oilfield equipment to the Debtor that was not used or did not generate any revenue during the bankruptcy case.  On December 18, 2015 the Debtor sold essentially all of its assets.  However, Premium’s lease was not assumed or assigned as part of the sale.

Subsequently, the Debtor moved to reject Premium’s lease and the Bankruptcy Court approved the motion and entering its order dated December 29, 2015.  Premium filed a motion for allowance of an administrative expense claim for unpaid rent for the period beginning from the date of petition through the rejection order.  Some of the Debtor’s unsecured creditors opposed the motion, claiming that the rental charges for the equipment were not actual and necessary expenses for the preservation of the Debtor’s estate.  The parties agreed to stipulated set of facts that the Bankruptcy Court relied exclusively on in reaching its decision.  Critical in the stipulated facts were statements from the Debtor’s officers, who in their combined business judgment believed that retaining Premium’s lease and equipment was necessary to avoid the substantial risk of losing revenues and critical customers if the Debtor ran short of equipment and potentially destroying the company’s enterprise value while it was being marketed for a Section 363 bankruptcy sale, compared to the significant higher costs of having to rent similar tools from other third parties.  Thus the Debtor’s officers “believed that the lease of the [equipment] was an actual and necessary expense of preserving the [Debtor’s] estate’s value. Id. at p. 5.

ANALYSIS

The Bankruptcy Court approved Premium’s administrative expense claim finding that (a) the term “benefit” does not require actual use of the equipment at issue if the business derives some benefit from its retention and (b) based on the testimony of the Debtor’s insiders, found that the Debtor made a conscientious decision to retain the leased equipment and that it was appropriate to consider this evidence in determining whether the expense benefitted the bankruptcy estate or not. Id. at p. 7.

On appeal, the appellants attempted to argue that Premium’s administrative expense claim must fail because a preexisting lease entered into before the bankruptcy was filed cannot be considered a transaction with a debtor in possession.  The District Court noted that case law throughout the country is to the contrary.  Id. at p. 10.  Moreover, it was noted that a lease is a different type of transaction than that of a sale of goods or services, in that a lease provides an ongoing exchange of benefits and obligations between the lessor and lessee for a specific term.  On the other hand, sales of goods and services typically are separate and distinct transactions.  Id. at p. 11. Therefore since the Debtor made an affirmative post-petition decision to retain possession of Premium’s equipment, it clearly constituted a transaction with the debtor in possession.

The District Court then went into an extended discussion on the two divergent lines of cases that have emerged regarding administrative expense claims for rent incurred under an equipment lease.  The first line of cases (Ninth Circuit) holds that administrative expense claims may be allowed based on the fair and reasonable value of the rental equipment without regard to whether the debtor actually uses the equipment.  the Court noted that it is reasonable to assume that the debtor is utilizing the leased property for its intended purpose until the debtor rejects the lease.  Id. at p. 13.  The other line of cases (Fourth and Tenth circuits) holds that lease payments should only be allowed as an administrative expense to the extent the debtor has made actual use of the leased equipment, thus providing a tangible benefit to the estate.  By minimizing the overall administrative expenses, the interest of unsecured creditors are protected.  Id. at p. 14. The District Court noted that the Fifth Circuit has yet to address whether the amount of an allowed administrative expense claim should be based on the fair rental value of the leased equipment due to tangible and intangible benefits to the estate or if actual use by the debtor is required.  Since there was no bright line test and it appeared that Premium’s leased equipment provided an intangible benefit to the Debtor, the District Court affirmed the administrative expense claim in favor of Premium.[2]

COMMENT

The Bankruptcy Code provides administrative expense treatment for unpaid rent incurred after the 60th day that a Chapter 11 bankruptcy case is commenced.  11 USC Section 365 (d)(5).  However, before the 60th day and when a personal property lease is rejected, the courts are divided on the treatment of administrative expense treatment for the rent accruing during the first 60 days of the case.  A further refinement of the question required the court in Kimzey to determine whether actual or intangible benefits meet the required standard.  The Rutter Group Practice Guide “Bankruptcy” 16-1180,  p. 16-69  (2017).  Kimzey responded by holding that intangible benefits may establish administrative expense treatment for equipment lessors and underscores how critical business judgment testimony by competent individuals was.  Parties opposing such treatment would be wise to avoid stipulated facts or be prepared to make sustainable evidentiary objections to the supporting statements.

One further issue that Kimzey did not address was whether the administrative expense claim should be based on the contract rate or the fair rental value of the equipment.  See., In re Pan American Airlines Corp., 245 BR 897, 899-900  (Bktcy. SD FL (2000)).  The Court simply adopted and used the contract rate contained in Premium’s lease, with no further analysis.

ABOUT COOPER, WHITE & COOPER LLP

Cooper, White & Cooper LLP is a mid-sized law firm with offices in San Francisco and Walnut Creek, California.  Founded in 1896, Cooper’s practice has expanded over its 100+ year history to provide comprehensive representation in most areas of business law and civil trial practice.  It is best known for its representation of clients in the areas of business, corporate, employment, media, telecommunications, insolvency, finance, public utilities and real estate law.

[1] The Memorandum Ruling is available on PACER in Case No. 6:16-cv-01490-EEF-CBW Document No. 17, Filed 03/14/18.

[2] The unsuccessful appellants also appealed the District Court’s ruling to the Fifth Circuit, Case No. 18-30447 on 04/11/2018; however, that appeal was conditionally dismissed to allow the parties to seek approval of a settlement in the Bankruptcy Court (Case No.15-51337), The settlement motion has been fully briefed and set for hearing on August 14, 2018. On August 21, 2018 Judge Robert Summerhays signed an order approving the parties’ settlement.