Finding that Underlying Development Agreement was Terminated, Delaware Bankruptcy Court Disallows Claim for Rejection Damages

by Cadwalader, Wickersham & Taft LLP
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[authors: Alicia B. Davis, Thomas Curtin]

On July 9, 2012, Judge Mary F. Walrath of the Bankruptcy Court for the District of Delaware disallowed a claim for rejection damages related to a real estate development agreement, because the claim had been released upon the termination of an LLC Agreement, and the underlying ground lease never came into existence. In re Magna Entm’t Corp., 2012 Bankr. LEXIS 3089 (Bankr. D. Del. July 9, 2012).

Background

In 2004, Santa Anita Associates Holding Corporation (“SAAHC”) and Magna Entertainment Corporation entered into a joint venture (the “LLC Agreement”) to develop a high-end shopping center adjacent to the Santa Anita Racetrack, which was owned by The Santa Anita Companies (“SAC”). As part of the LLC Agreement, SAAHC and Santa Anita Enterprise each owned a 50 percent interest in a newly formed LLC and SAAHC acted as the managing member. Although SAC was not a party to that agreement, it was contemplated (and confirmed in a letter by SAC) that SAC would enter into a ground lease of the property with the newly formed LLC if certain conditions were met.

The LLC Agreement provided that if certain recapture conditions (including zoning approvals and entering into a reciprocal easement agreement) were not met, then, subject to extension due to a “force majeure,” the LLC would have the option to elect to terminate the LLC Agreement, the ground lease, and all other applicable agreements.

In addition, the LLC Agreement provided for termination if the parties did not enter into a reciprocal easement agreement within 90 days of the effective date of the agreement. A final reciprocal easement was never reached, and consequently, the LLC sent written notice of termination to SAAHC. SAAHC sought an extension of the deadline to enter into the reciprocal easement agreement, but it never did so, as the City Council rescinded its approval of the project after a neighborhood group successfully moved in state court to partially overturn the project’s approval.

The Debtors, including Magna Entertainment and SAC, filed for chapter 11 on March 5, 2009. During the case, the Debtors successfully marketed their assets for sale, including the Santa Anita Racetrack and their interest in the joint venture with SAAHC. The sale and the Debtors’ plan of reorganization became effective on April 30, 2010. The Debtors rejected their contracts with SAAHC and the LLC under the plan. Shortly before confirmation, the LLC sent notice of termination of the LLC Agreement predicated on the failure to satisfy conditions precedent set forth in the LLC Agreement in a timely manner and that such termination would become effective on May 12, 2010.

Subsequently, on May 28, 2010, SAAHC and the LLC filed a proof of claim against the Debtors in excess of $21 million for damages relating to SAC’s failure to enter into the ground lease. The Debtors filed an objection to the claim, in which the Creditors’ Committee joined, on the basis that the claim had been released as a result of the termination of the LLC Agreement. The Debtors pointed to a section of the LLC Agreement, which provided that if the agreement was terminated, then the parties would be released from all claims relating to the ground lease and other related agreements. In addition, the Debtors argued that SAAHC’s claim was invalid because SAC never entered into a ground lease with the LLC and it could not do so until certain conditions precedent were met.

In response, SAAHC maintained that the releases in the LLC Agreement were not effective because the termination did not take place until after the Debtors had rejected the ground lease. SAAHC also argued that SAC and the LLC had entered into a valid agreement to enter into the ground lease, whose terms were detailed in the LLC Agreement.

Bankruptcy Court’s Decision

The Bankruptcy Court ultimately disallowed SAAHC’s and the LLC’s proof of claim on the grounds that the Debtors properly terminated the LLC Agreement, which, in turn, also terminated the Debtors’ ground lease obligations. The Bankruptcy Court based its ruling on several considerations.

First, the Bankruptcy Court considered whether the LLC Agreement was terminated. SAAHC argued that the agreement was not terminated because it had properly requested an extension based on its litigation against the City Council, which it maintained was a force majeure under that agreement. The Debtors contended that the LLC Agreement terminated because (i) SAAHC failed to provide the requisite notice to obtain an extension for a force majeure, and (ii) it would not be reasonable for SAAHC to request an extension when it failed to take any actions to satisfy the preconditions for five years.

The Bankruptcy Court agreed with SAAHC that the litigation over the City Council approval fit within the LLC Agreement’s definition of force majeure. Even so, the Bankruptcy Court found that SAAHC did not comply with the requirements of that agreement, which required that SAAHC provide adequate notice in order to obtain an extension for a force majeure. In support of this conclusion, the Court pointed to delays such as the failure to seek arbitration over the termination of the LLC Agreement, failing to seek relief from the automatic stay to proceed with litigation against the Debtors, and failing to negotiate an acceptable reciprocal easement agreement in reaching its conclusion. These delays, according to the Bankruptcy Court, were not reasonable and supported the conclusion that the Debtors properly terminated the LLC Agreement on May 12, 2010.

Second, the Bankruptcy Court turned to the issue of whether the ground lease constituted a separate agreement between SAC and the LLC. The Debtors argued that there was no ground lease because SAC would only enter into the lease if the recapture conditions were satisfied. Those conditions were never satisfied.  Since the LLC Agreement was terminated, the Debtors contended that the ground lease never came into existence. SAAHC, on the other hand, maintained that the ground lease was an enforceable contract under applicable state law, that SAC’s confirmation letter constituted the agreement, and that all of the material terms were set forth in the LLC agreement.

The Bankruptcy Court agreed with the Debtors and found that the ground lease never came into existence and that there was no enforceable ground lease with SAC. The confirmation letter, which was the only writing executed by SAC, was conditioned on the fulfillment of the recapture conditions. SAAHC acknowledged that those conditions were never met. In addition, the Bankruptcy Court noted that even if the contract to enter into the ground lease existed, that contract was terminated through the termination of the LLC Agreement. The termination of that LLC Agreement released all claims that SAAHC had against the Debtors and SAC.

Finally, the Court held that the release of all claims under the LLC Agreement meant that SAAHC was not entitled to any rejection damages, regardless of whether the Debtors previously rejected the agreement. SAAHC asserted that even if the LLC Agreement had been properly terminated on May 12, 2010, it was nevertheless entitled to rejection damages because the Debtors previously rejected their contracts with SAAHC under their plan of reorganization. The Court rejected this argument, finding that SAAHC was not entitled to rejection damages because the termination of the LLC Agreement released all claims related to that agreement. The Court held that the release included all claims that SAAHC had against SAC, “including those that arose before the termination as a result of the rejection of any lease or contract” that SAC had with SAAHC. Id. at *17-18.

In sum, as the ground lease never existed and the LLC Agreement was properly terminated, the Bankruptcy Court sustained the Debtors’ objection and disallowed SAAHC’s claim.

Conclusion

The Magna decision applies a common sense approach to the allowance of claims by examining the behavior of the parties and the underlying contracts governing their relationship. Where, as here, the underlying agreement has been properly terminated and the agreement provides for the release of all claims upon termination, a bankruptcy court would likely disallow a claim for rejection damages, regardless of whether the debtor previously rejected that contract.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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