One of the quandaries of Chapter 11 bankruptcy law is understanding what is an “executory contract” and what is not; the distinction is critical for appreciating what obligations can be scraped off, like mud from your shoes, if you decide to take this route as a tactical way to save your business or your assets (if you’re out of business). The bankruptcy code is not helpful in defining an executory contract, although everyone has an intuition what it is. The intuition usually is that an executory contract is one that isn’t “completed on both sides.” An executed contract, by contrast, is one that is finished; no performance by anybody remains, in other words.
Seems elementary enough; if someone has additional obligations left, then the contract is executory, right? Under the bankruptcy rules, a debtor who is a party to an executory contract may either reject the contract, affirm it (continuing performance following affirmation) or affirm and assign the contract to a third party (passing on the obligations to the assignee). Where real property-driven agreements are concerned, the waters of clarity are murky. This is because at times, bankruptcy courts, particularly appellate ones, will interpret certain types of contracts as conveying “real property rights” or “interests,” at which point there is doubt whether the election of a bankruptcy debtor persists. There is some irony here; for years in the commercial leasing context, American appellate courts have been eschewing the application of “property rights” concepts in favor of treating leases as contracts, without property heritage obeisance. For example, commercial leases in Arizona incorporate an implied covenant of good faith and fair dealing; this is unusual, because in a strict property rights milieu, good faith isn’t relevant. Think of fiefdoms and lords and vassals. Good faith in medieval times? What?
About 18 months ago, the 9th Circuit Bankruptcy Appellate Panel (“BAP”) weighed in on this issue. The Debtors, named Hayes, wanted to reject restrictive covenants relating to lakeside residential subdivision lots that lowered their property value (because they had a deterrent effect on the sale of the property), or merely were a source of aggravation. The bankruptcy court ruled that residential restrictive covenants do not make an executory contract that could be rejected under Bankruptcy Code §365(a). Hayes appealed; and three judges on the BAP considered the issue. The panel referred to a 1998 opinion from the 9th Circuit Court of Appeals (In re Robert L. Helms Construction) in finding that a contract is executory if the obligations of each party are “so unperformed” at the date of the bankruptcy filing that either party’s failure to complete performance constitutes a material breach of the agreement at issue. In the 1998 Helms opinion, the 9th Circuit held that an option contract is not executory because the optionee’s only true obligation, payment for the option right, is discharged at the time the option arrangement is made. In other words, one party was essentially “done” performing when that bankruptcy was filed; and at least some further performance by each party is required to find an executory contract.
So, the BAP in Hayes’ instance found that while the debtors had an ongoing obligation to comply with the CC&Rs, the Association had few if any continuing obligations. (The only one cited by the judges was the Association’s right – not obligation, in the perspective of the BAP panel – to expel any offending landowner in the subdivision.) The BAP panel pointed out that this didn’t rise to the level of “mutual obligations” at the time the bankruptcy petition was filed or afterwards. The bankruptcy court’s decision was therefore affirmed.
Hmm. So much for the reach of contract law into the realm of real property rights. The BAP panel neglected to comment upon the multiparty dimension of CC&Rs; these actually are “group contracts” among all landowners who are subject to the restrictive covenants – apart from the Association as a party. In other words, each owner has an ongoing obligation to every other landowner in the subdivision not to violate the restrictions on use and other CC&Rs requirements, like maintenance of and insuring their lots, or payment of common area assessments. (That’s why most CC&Rs state that enforcement may be had by the owners’ association or any individual owner or owners.) I suspect that this is a convention of common law in every state in the U.S., although such a convention may have been changed by statute in some jurisdictions. Those obligations to behave in a neighborly way continue in effect every day of a subdivision’s existence. Well, never mind the neighbors. But, be careful if you think that a “property right”-oriented agreement like an option to purchase/lease or a right of first refusal is dischargeable in your bankruptcy, at least in the 9th Circuit states.
-MNW
Friday, August 21, 2009
Monday, August 17, 2009
MORE MECHANICS’ LIEN MACHINATIONS
On January 26, 2009, this Blog informed you about the Galeb-Miller v. Markham Contracting case on appeal that would be argued the following week, and invited your continued attention to those proceedings. The opinion in the case (1 CA-CV 07-0872) was published as a Memorandum Decision (e.g., one not to be used as precedent in future Arizona litigation) on May 19, 2009. So, was this blogista inattentive? Not really; the loser – big loser, actually, filed a motion for reconsideration in June, and the briefing on that motion was concluded just a few weeks ago. The Galeb case involves the imposition of damages in the form of a penalty upon a party (here, the contractor, supposedly) for the filing in the public records of a groundless lien under A.R.S. Section 33-420, the false lien statute. The big loser here was the owner; the Court of Appeals is being asked to reconsider its decision to deny Galeb-Miller any manner of damages whatever arising under the statute.
The factual background is that Markham Contracting’s attorney filed a lawsuit to foreclose on a lien, and concurrently recorded a notice of lis pendens confirming the existence of a suit and the entitlement of the contractor to a claim sounding in ownership against the real property. Problem was, Galeb earlier had procured and recorded surety lien-discharge bonds to “insure over” the claim of mechanic’s lien before the lis pendens recorded. (By operation of law, the recording of such bonds discharged Markham’s liens.) Now, the surety was one Contractors Bonding and Insurance Co. (“CBIC”); the attorney for Markham had obtained from a title company a “litigation guarantee” report, which identified an interest in the property owned by CBIC. The title company did not apparently disclose the capacity in which CBIC had an encumbrance against title, and the attorney did not inquire – at least, not until it was served with the bonds, into the nature of CBIC’s interest in the property. But the counsel knew that the title company had identified CBIC as a party in interest, who had to be named in the suit (and was not, for reasons unknown here).
The parties tried to settle, but got stuck in a few places, so Galeb sued and asserted it was entitled to damages for the violation of the statute on several groundlessness grounds, being:
a. Markham’s principals knew that the lis pendens was groundless themselves;
b. Markham’s attorney’s knowledge must be imputed to Markham if the officers knew the lis pendens was being recorded, and IF the attorney knew or had reason to know that the lis pendens was groundless;
c. Markham’s counsel was an agent for Markham, and therefore the knowledge of the attorney should be imputed to the principals under common law agency doctrine; and
d. Markham’s lien filings asserted termination fees and interest, categories of expense that are not recoverable under the mechanics’ lien statutory scheme (aka “non-lienable damages”).
Our court of appeals ruled that:
(i) Markham neither knew or had reason to know the discharge bonds had been filed, and did not read the “litigation guarantees,” so Markham likely did not know that the lis pendens filings were groundless; and
(ii) It was improper for the trial court to impute the attorney’s knowledge about the CBIC bonds, which was incomplete at best, to Markham; and
(iii) Because Markham had a good faith belief that it could rightfully impose a lien and therefore refused to relinquish it after demand from the owner, the contractor cannot be acting in bad faith, because the lien statutes are obscure.
Galeb got nothing in damages in the appeal; and the Court of Appeals opinion ends by remanding the matter to Superior Court for fact findings on whether the liens contained a material misstatement or false claim, and whether a letter sent to Markham’s counsel imputed to Markham (or afforded to Markham actual) knowledge that the liens were at least partially invalid due to the termination fees and interest that is statutorily unrecoverable. Galeb filed for reconsideration, likely because it went from having several hundred thousand dollars in a settlement posture to having squatola, other than a big bill from its counsel. So, we await the outcome of the motion to reconsider, and the treatment of the likely Notice of Appeal to the Supreme Court of Arizona to be filed by Galeb to follow.
The Court of Appeals had a little footnote of interest in its decision, numbered 18; it says that given that the recording of the bonds “killed” the mechanics’ liens in the total amount of those bonds, Markham only can be liable for the balance (the amount of the liens not discharged by the recorded bonds) under ARS 33-420. That’s interesting since the lis pendens was recorded after the bonds were; that lis pendens remained of record, which might arguably have chilled prospective purchasers’ inquiries about the property. Maybe someone will reconsider the wisdom of that footnote or at least explain what the Court was thinking along those lines. Also, it would be nice to hear from a court why Markham isn’t required to review the exceptions noted on the litigation guaranty report from the title company, once it has notice that there’s an evident conflicting claim of an encumbrance against the property. Eventually.
--MNW
The factual background is that Markham Contracting’s attorney filed a lawsuit to foreclose on a lien, and concurrently recorded a notice of lis pendens confirming the existence of a suit and the entitlement of the contractor to a claim sounding in ownership against the real property. Problem was, Galeb earlier had procured and recorded surety lien-discharge bonds to “insure over” the claim of mechanic’s lien before the lis pendens recorded. (By operation of law, the recording of such bonds discharged Markham’s liens.) Now, the surety was one Contractors Bonding and Insurance Co. (“CBIC”); the attorney for Markham had obtained from a title company a “litigation guarantee” report, which identified an interest in the property owned by CBIC. The title company did not apparently disclose the capacity in which CBIC had an encumbrance against title, and the attorney did not inquire – at least, not until it was served with the bonds, into the nature of CBIC’s interest in the property. But the counsel knew that the title company had identified CBIC as a party in interest, who had to be named in the suit (and was not, for reasons unknown here).
The parties tried to settle, but got stuck in a few places, so Galeb sued and asserted it was entitled to damages for the violation of the statute on several groundlessness grounds, being:
a. Markham’s principals knew that the lis pendens was groundless themselves;
b. Markham’s attorney’s knowledge must be imputed to Markham if the officers knew the lis pendens was being recorded, and IF the attorney knew or had reason to know that the lis pendens was groundless;
c. Markham’s counsel was an agent for Markham, and therefore the knowledge of the attorney should be imputed to the principals under common law agency doctrine; and
d. Markham’s lien filings asserted termination fees and interest, categories of expense that are not recoverable under the mechanics’ lien statutory scheme (aka “non-lienable damages”).
Our court of appeals ruled that:
(i) Markham neither knew or had reason to know the discharge bonds had been filed, and did not read the “litigation guarantees,” so Markham likely did not know that the lis pendens filings were groundless; and
(ii) It was improper for the trial court to impute the attorney’s knowledge about the CBIC bonds, which was incomplete at best, to Markham; and
(iii) Because Markham had a good faith belief that it could rightfully impose a lien and therefore refused to relinquish it after demand from the owner, the contractor cannot be acting in bad faith, because the lien statutes are obscure.
Galeb got nothing in damages in the appeal; and the Court of Appeals opinion ends by remanding the matter to Superior Court for fact findings on whether the liens contained a material misstatement or false claim, and whether a letter sent to Markham’s counsel imputed to Markham (or afforded to Markham actual) knowledge that the liens were at least partially invalid due to the termination fees and interest that is statutorily unrecoverable. Galeb filed for reconsideration, likely because it went from having several hundred thousand dollars in a settlement posture to having squatola, other than a big bill from its counsel. So, we await the outcome of the motion to reconsider, and the treatment of the likely Notice of Appeal to the Supreme Court of Arizona to be filed by Galeb to follow.
The Court of Appeals had a little footnote of interest in its decision, numbered 18; it says that given that the recording of the bonds “killed” the mechanics’ liens in the total amount of those bonds, Markham only can be liable for the balance (the amount of the liens not discharged by the recorded bonds) under ARS 33-420. That’s interesting since the lis pendens was recorded after the bonds were; that lis pendens remained of record, which might arguably have chilled prospective purchasers’ inquiries about the property. Maybe someone will reconsider the wisdom of that footnote or at least explain what the Court was thinking along those lines. Also, it would be nice to hear from a court why Markham isn’t required to review the exceptions noted on the litigation guaranty report from the title company, once it has notice that there’s an evident conflicting claim of an encumbrance against the property. Eventually.
--MNW
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