d/b/a California Waterbeds; CHAPTER 11

Future Rest





The matter before the Court in this case deals with rents as administrative expenses and the surcharging of collateral of a secured creditor. Questions of jurisdiction have been raised by the parties. The movant, Brookhaven Trust Properties ("Brookhaven"), leased commercial property to Waterbed Galleries, Inc. d/b/a California Waterbeds ("Waterbed Galleries") for one of its stores. The lease was assumed after the filing of the Chapter 11 case, and a note was entered into to cure arrearages as well. Subsequent to these events, a plan of reorganization proposed by the debtor was confirmed.

Brookhaven seeks administrative expenses totaling $284,109.40 which it says are due it under the lease, plus $13,066.57 due under the note, all pursuant to 11 U.S.C. '503(b). In addition it seeks $19,593.75 as the reasonable and necessary costs of selling Waterbed Galleries' inventory pursuant to 11 U.S.C. '506(c). Waterbed Galleries apparently decided to go out of business some time after its Chapter 11 plan was confirmed on June 14, 1995, and held liquidation sales beginning in August 1996.

As concerns the part of Brookhaven's motion that seeks amounts due under the lease and note as administrative expenses, Waterbed Galleries has filed its Objection to Motion for Payment of Administrative Expenses and for Recovery of Payments contending that Brookhaven's request to be awarded administrative priority on the subject note must fail as the note is a loan from Brookhaven and cannot be characterized as rents. Waterbed Galleries maintains that this portion of Brookhaven's claim can only be considered a general unsecured claim.

Brookhaven responds that the note was part of the adequate assurance required to be paid pursuant to 11 U.S.C. '365(b)(1)(B) before the lease could be assumed. Brookhaven maintains that the Court's Order of March 23, 1994, establishes the administrative expense nature of the payment of arrearages by requiring that they be paid pursuant to the terms of the note. Brookhaven has cited In re Klein Sleep Products, Inc., 78 F.3d 18 (2nd Cir. 1996) in support of its position. The Klein Sleep Products court stated:

According to 11 U.S.C. '503(b)(1)(A), 'the actual, necessary costs and expenses of preserving the estate' constitute administrative expenses entitled to priority status upon distribution of the estate. The crux of [the landlord's] argument is that a trustee's or debtor-in-possession's assumption of an unexpired lease transforms all liability under the lease, including damages that stem from a subsequent rejection of the lease into administrative expenses.

. . . . . .

Multech [In re Multech Corp., 47 B.R. 747, 750 (Bkrtcy.N.D.Iowa 1985)], the seminal case on this issue, offers the following rationale for this rule:

'By defining the time at which a rejection of an assumed contract or lease constitutes a breach, section 365(g) clearly indicates that the act of assumption creates an administrative expense obligation of the particular proceedings in which the contract or lease was assumed. Consequently, if a lease is assumed in a Chapter 11 proceeding, the liabilities flowing from the rejection of that lease will ever after be regarded as a Chapter 11 administrative expense.'

47 B.R. at 750 (footnote omitted).

At pages 22-23.

The Klein Sleep Products court goes on to discuss the timing provisions of the Bankruptcy Code that support the proposition that all future rent is an administrative expense:

When a debtor rejects an unassumed lease, breach is deemed to occur at the same time the bankruptcy petition was filed. 11 U.S.C. '365(g)(1). If the lease has been assumed, however, breach is deemed to occur whenever the lease is later rejected. '365(g)(2)(A). According to the Code's legislative history, the purpose of '365(g) is to treat claims arising from unassumed leases 'as prepetition claims.' .... But the only way in which prepetition claims are treated differently from postpetition claims is that the former are classified as general claims, whereas the latter--arising, for example, from torts committed by the estate in bankruptcy, or from contracts entered into by the trustee or debtor-in-possession--are entitled to administrative expense priority. It would seem to follow that rejection of an assumed lease--that is, breach of contract committed by the trustee or debtor-in-possession while administering the estate--gives rise to a debt entitled to the same administrative expense priority. (Cite omitted.)

At page 26. The Court finds that the subject note is evidence of the obligation to pay rent and cure the then existing default in the lease pursuant the Court=s order allowing assumption and not a separate obligation. Rent due under the lease up to the point of confirmation of the plan is an administrative expense. The issue of post-confirmation rent due on an assumed lease as an administrative expense is reserved, and will not be ruled on, as it is not specifically addressed, nor adequately treated herein. Farmers Bank and Capital Trust Co. ("Farmers Bank") opposes Brookhaven's motion in regard to the surcharge of collateral. Farmers Bank was a creditor secured by substantially all of Waterbed Galleries' inventory and assets; it states that it is still owed $952,128.29 on its prepetition claims. It asserts that the motion must be overruled in regard to the surcharge of collateral and recovery of funds because Brookhaven lacks standing to make such a motion, and the Court lacks jurisdiction to enter such an order.

Brookhaven bases its position on several elements, the first of which is the language of paragraph 10.2 of the Chapter 11 plan in which the Court retained jurisdiction "[t]o determine all Claims, and the amount thereof, arising from the rejection of executory contracts and unexpired leases and to hear and determine all matters relating to the assumption and assignment of executory contracts and unexpired leases." It also looks to 11 U.S.C. '506(c) in regard to the issue of surcharge of collateral. That statute provides that "[t]he trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim."

Brookhaven also cites In re Visual Industries, Inc., 57 F.3d 321 (3rd Cir. 1995) in support of its position on the issue of surcharging collateral. The Visual Industries court does support Brookhaven on the issue of standing. It held that "[a]lthough '506(c) in terms refers only to recovery by the trustee, we, like many other courts, have held that administrative claimants other than trustees have standing to recover under '506(c), particularly when no other party has an economic incentive to seek recovery on the claimant's behalf." At page 325. Clearly, then, Brookhaven has standing to bring its motion in this regard. However, the Court must first decide whether '506(c) applies in a post-confirmation situation. Farmers Bank contests Brookhaven's assertion of this Court's jurisdiction to rule on its motion, and cites in support In re Cary Metal Products, Inc., 152 B.R. 927 (N.D.Ill. 1993). The jurisdictional question aside, this Court finds no support for the application of '506(c) post-confirmation. As stated in In re Maine Pride Salmon, Inc., 180 B.R. 337 (Bkrtcy.D.Me. 1995):

Upon confirmation of a Chapter 11 plan Chapter 5's provisions have served their purpose: they have provided the rules determining 'who gets what when.' Thus, although '506(c) does not expressly state that it ceases to operate at confirmation, its context, function and content demonstrate that it does.

. . . . . . . . . . . . .

[L]imiting '506(c)'s operation to pre-confirmation expenses makes sense. A Chapter 11 debtor reorganizes with the aim of emerging from bankruptcy with a reformulated, feasible debt structure. Creditors may or may not choose to deal with the reorganized entity. Those who do deal with it are free to assess attendant risks and to strike their own deal, cognizant of constraints the confirmed plan imposes.

At pages 341-342. Since 11 U.S.C. '506(c) does not apply to such post-confirmation transactions, the motion of Brookhaven should be overruled in this regard.

An order in conformity with this opinion will be entered separately.





By the Court -






Copies to:


James W. Gardner, Esq.

Joseph M. Scott Jr., Esq.

Michael W. Troutman, Esq.

U.S. Trustee