Karykeion, Inc.

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UNITED STATES BANKRUPTCY COURT
CENTRAL DISTRICT OF CALIFORNIA
In re:
Karykeion, Inc.,
Debtor(s).
Case No: 1:08-bk-17254-MT
Chapter: 11
MEMORANDUM OF DECISION
RE: BLC2’s MOTION FOR PAYMENT OF
ADMINISTRATIVE CLAIM
Date: July 21, 2010
Time: 11:00am
Location: Courtroom 302
I. Background
In February of 2007, Karykeion (“debtor”) borrowed $1.975 million and $515,000 from CDC
Direct Capital (“CDC”). In return, CDC took a 2nd priority deed of trust in the debtor’s two real
property assets, Mission Hospital and the Medical Office Building. CDC later assigned this
note and security interest to Business Loan Conduit #2 (“BLC2”). Unbeknownst to CDC or
BLC2, debtor, in early 2007, transferred Mission Hospital and the Medical Office Building to a
group commonly known as the CIG group. In an effort to hide this transfer, the debtor
continued to directly pay BLC2’s promissory notes. Until the bankruptcy, debtor’s subterfuge
worked; BLC2 remained unaware of the transfer. Filing the bankruptcy, however, revealed the
transfer. At the onset of the case, the debtor proposed treating BLC2 as a partially secured
FILED & ENTERED
AUG 16 2010
CLERK U.S. BANKRUPTCY COURT
Central District of California
BY DEPUTY CLERK	adomingu
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creditor. As a partially secured creditor, debtor paid BLC2 adequate protection payments. Over
the course of the case, these payments amounted to more than $125,000. Debtor, as its cash
flow worsened, only sporadically made the payments. After the debtor filed, BLC2 initiated a
state court action against Edward Rubin, guarantor to CDC’s initial notes. In May of 2009, the
debtor, Rubin, and BLC2 signed a stipulation. As part of the stipulation the debtor would
continue making payments to BLC2 and make up the arrearages in its post-petition payments.
Debtor also agreed to treat BLC2 as fully secured and confirm a plan treating them as fully
secured. BLC2, agreed to waive the debtor’s violation of the due on sale clause. Debtor had
until December 31, 2009, to confirm a plan including these provisions. Debtor proved unable to
make continuing payments and no plan encompassing the settlement was confirmed. In early
2010, the debtor proposed a new liquidating plan. This liquidating plan did not encompass the
settlement and instead treated BLC2 as a fully unsecured creditor.
BLC2 objected to the liquidating plan, which has now been withdrawn. BLC2 now makes a
motion to treat its approximate $2.9 million claim as an administrative claim. BLC2 argues that
the settlement entitled it to a fully secured position and if the debtor does not treat it as fully
secured, then it is entitled to damages in the full amount of its claim. Because these damages
arose post-petition, BLC2 argues they are entitled to administrative priority.
II. Discussion
A. No Breach of the Settlement Agreement
BLC2 argues that debtor’s failure to confirm a plan by December 31, 2009, is a breach of the
settlement agreement. It is not. Paragraph 3, describing BLC2’s treatment under a proposed
plan of reorganization, indicates that:
Plaintiff would be treated as fully secured for purposes of these payments, adequate
protection payments, and for the plan of reorganization ultimately adopted in this
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case,…. If no such plan is timely confirmed as per below, we would be treated on a
going forward basis after that point, as an unsecured creditor to the extent deemed
unsecured…. There would be a drop dead date of December 31, 2009, by which such a
plan acceptable to us would have to be confirmed….
This language requires the debtor to treat BLC2 as fully secured in any plan confirmed prior to
December 31, 2009. The language does not make a failure to confirm such a plan a breach of
the settlement agreement. In fact, ¶3 with the language “if no such plan is timely1 confirmed as
per below, we would be treated… as an unsecured creditor” expressly contemplates a failure
to confirm a plan, prior to December 31, 2009, that treats BLC2 as fully secured. According to
the settlement, BLC2 becomes an unsecured creditor.
BLC2 argues that the December 31, 2009 date was included for its benefit and it may waive
the provision. The law allows a party to waive a term of a contract when that term is solely for
the benefit of the party waiving the terms. See In re Marineland Ocean Resorts, Inc. 242 B.R.
748, 757 (Bankr.M.D.FL 1999)(allowing a party to a franchise agreement to waive the
requirement that they consent in writing prior to the assignment of the agreement). BLC2 has
not presented adequate evidence to show that the December 31, 2009, date was included
solely for its benefit. The date benefits BLC2 in that it requires the debtor try and confirm a plan
that treats BLC2 as fully secured and the date entitles BLC2 to a certain number of plan
payments. The time limit however also confers a benefit on the debtor, for once the date
passes the debtor no longer must propose a plan that treats BLC2 as fully secured, reopening
the debtor’s option to vary BLC2’s treatment. Thus, the date does not appear to be a covenant
inserted solely for the benefit of BLC2, preventing BLC2’s waiver. 2
1 BLC2 omits timely from its motion for an administrative expense. BLC2 uses the phrase “if no such plan is
confirmed.” BLC2 quotes the debtor’s synopsis of the settlement agreement, included in debtor’s
motion to approve the settlement agreement. The settlement agreement itself uses the word timely in
the relevant phrase.
2 Because the court finds that BLC2 cannot waive the provision, the court does not need to reach the
argument that BLC2 is only treated as an unsecured creditor if no plan is confirmed.
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BLC2 further argues that even if the debtor did not breach the settlement agreement, the
agreement requires the debtor make loan payments until the loan is paid in full, effectively
creating an administrative expense in the amount of the unpaid portion of the loan. For this
interpretation, BLC2 relies on ¶2 of the agreement. Paragraph 2, in relevant part, requires the
debtor to make all payments required under the original note and payments of $3,662 on a
monthly basis. Paragraph 3, as quoted above, only requires the debtor to treat BLC2 as fully
secured until December 31, 2009 or in any plan confirmed prior to that date. If a plan is not
timely confirmed, BLC2 reverts back to its status as of the case filing; an undersecured creditor
to an unknown extent. As an undersecured creditor going forward, BLC2 is entitled to keep
any payments received pursuant to the settlement agreement and is entitled to all payments
coming due between consummation of the agreement and December 31, 2009, but it is not
entitled to full payment of its pre-petition claim on a going forward basis. Thus, when BLC2
secured status changed on December 31, debtor no longer had to make payments required
under ¶2.3 Thus, the debtor did not breach the settlement agreement by stopping payments to
BLC2 after December 31, 2009 and not proposing a plan that treated BLC2 as fully secured.
B. BLC2’s CLAIM DOES NOT QUALIFY AS AN ADMINISTRATIVE EXPENSE
Even if debtor breached the agreement and BLC2 is entitled to a $2.9 million claim for that
breach, the breach does not qualify as an administrative expense because the claim does not
meet either part of the administrative priority test. To be entitled to administrative priority: (1) a
debt must arise from a transaction with the debtor-in-possession, and (2) be beneficial to the
debtor-in-possession in operation of the business. In re Mammoth Mart, Inc., 536 F.2d 950,
954 (1st Cir. 1976); In re Sunarhauseerman, Inc., 126 F.3d 811, 816 (6th Cir. 1997).
3 This would not be true if BLC2 was fully secured on the day of the filing. There is no evidence in the
record that suggests that this was the case.
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1. BLC2’s claim is not a post-petition claim
For a debt to arise from a transaction with the debtor in possession, the debt must be incurred
post petition. Abercombie v. Hayden Corp. (In re Abercombie) 139 F.3d 775 (9th Cir. 1998),
Kadjevich v. Kadjevich (In re Kadjevich) 220 F.3d 1016 (9th Cir. 2000). The Kadjevich case
involved a somewhat similar situation to the one at issue. In Kadjevich, the court dealt with a
dispute between two brothers over the estate of their deceased mother. Id. In 1980, Angela
Kadjevich died. At the time of her death, she owned a number of properties. Id. One son,
Robert Kadjevich, administered the properties. In 1983, his brother, Nicholas Kadjevich sued
for an accounting. The parties settled but Robert breached the settlement. In 1985, Nicholas
sued Robert for fraud. In 1987, Robert filed a Chapter 11 bankruptcy proceeding. In 1990,
post-petition, Robert and Nicholas again settled the dispute. Robert, however, breached this
post-petition settlement agreement. Nicholas went back to the state court and obtained a fraud
judgment. Id. The state court found for Nicholas and awarded damages and $150,000 in
lawyers fees for bad-faith breach of the post-petition settlement agreement. Id. In September
of 2009, the estate converted to one under Chapter 7. Nicholas and the Trustee came to an
agreement where Nicholas would credit bid his claim of $150,000 for breach of the post-
petition settlement agreement. Id. at 1019. The bankruptcy court overruled this settlement
because it found the $150,000 a pre-petition unsecured claim. The Ninth Circuit upheld this
finding on the basis that the damages award, and the award of attorneys fees for the breach of
a post-petition settlement agreement, was a pre-petition claim because the source of the
award was a pre-petition fraud cause of action.
Similarly, BLC2 has a pre-petition claim for breach of its promissory note and deed of trust.
The parties settled this dispute post-petition with an agreement that the debtor would treat the
note as secured in any plan and would continue to make payments under the note. The debtor
allegedly breached this settlement agreement. Under Kadjevich, a court does not focus on
when the alleged breach occurred but instead looks at the nature of the transaction giving rise
to the settlement and the alleged breach. In this case, BLC2 had a pre-petition claim that the
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parties settled and the debtor allegedly breached. Because the “’source’” of the settlement
agreement and the alleged $2.9 million in damages is the breach of the pre-petition promissory
note, the $2.9 million does not qualify as an administrative expense because it is not based on
a post-petition transaction. See id. at 1020.4
2. There is no evidence that the settlement agreement benefited the debtor in
possession in operating its business.
There is no evidence that the settlement aided the debtor. The only term of the settlement that
might be construed as aiding the debtor is BLC2’s agreement to waive the non-monetary
default caused by the debtor’s pre-petition violation of the due on sale clause. It is unclear
however, what benefit this waiver provided. If BLC2 had waived the due on sale clauses,
debtor could have treated BLC2 as an unimpaired class and BLC2 would not have had to vote.
This benefits BLC2 and the benefit to the debtor is unclear.
There was some discussion of whether the debtor's ability to put the BLC2 dispute aside for
some period of time and not face litigation over the "due on sale fraud" was a benefit to the
estate. As there were so many moving parts to the case at that point and so many different
considerations affecting the debtor's choices over what to litigate and which party would have
been able to prevail on which claim, conclusions over how beneficial the settlement was to the
estate would be speculative. A benefit to the estate must be "actual" and not potential. In re
Dant & Russell, 853 F.2d at 706. Averting possible litigation is not enough. In re Allen Care
Centers, 175 B.R. 397 (D. Ct Or 1994)
Administrative expenses are a narrow category of expenses entitled to priority because without
priority no party would provide services to the estate. Traditionally, courts interpret
administrative expenses narrowly because giving some creditors a priority reduces the payout
4 This result might be different for specific payments required under the agreement. BLC2 and the
debtor, however, did not breach this issue
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to lower priority creditors and unsecured creditors. If the breach of any court approved
settlement agreement entitled the non-breaching creditor to priority status, the scope of priority
creditors would be expanded to encompass creditors with pre-petition claims that settled these
claims post-petition. This would prejudice other non-settling unsecured creditors and
potentially allow a debtor to pick and choose which pre-petition creditors would be entitled to
priority payment. This is antithetical to Code’s goal of paying all similarly situated creditors
equally.
BLC2 also argues that the court's finding under In re A & C Properties, that the settlement
"was in the best interests of the estate" is res judicata that the settlement conferred a benefit to
the estate under § 503. 784 F.2d 1377, 1380 (9th Cir. 1986). BLC2 relies heavily on In re Hink
& Son to argue that the settlement agreement order was res judicta and now that they have
relied on it, it must be enforced. 815 F.2d 1314 (9th Cir 1987) While this argument certainly
had some initial appeal, this reads too much into Hink & Son. Here BLC2 has moved for an
administrative expense claim which has a clear set of requirements under §503(b)(1)(A). The
finding required for a Rule 9019 motion is a different issue than the finding required for an
administrative expense. Settlements are preferred and great deference is given to the debtor.
The “best interests of the estate” is a broad concept, encompassing a variety of benefits, often
including the generic reduction in likely litigation costs. A §503(b) analysis, on the other hand,
is to be strictly construed and a very specific and quantifiable benefit must be identified. Thus,
the same issue was not previously litigated. In Hink & Son, the debtor assigned certain
“sweetheart” leases to Cukierman. At a court hearing, Cukierman repeatedly confirmed that
he understood that the rent could increase after assignment. After the assignment was
complete and the rent raised, Cukierman appealed the order, arguing that the rent increase
was prohibited by section 363(f)(3). The court rejected this argument and held that Cukierman
had clearly indicated his consent to the increased rent term, his waiver of 365(f)(3) was relied
on by the debtor, the trustee and the court, and he was estopped from making an opposite
argument after that. This differs from the situation at bar. As described above, the best interest
of creditors for purposes of a settlement and benefit to the debtor for purposes of an
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administrative claim are different inquiries and a finding that a settlement is in the best interest
of creditors does not preclude a finding that there is no benefit to the estate for an
administrative priority finding.
While the $2.9 million claim in not an administrative claim, the debtor did represent that BLC2
was an undersecured creditor at the outset of the case and made approximately $125,000 in
adequate protection payments. It appears that the debtor believed there was some amount of
the claim still secured at the outset of the case. While the total claim of BLC2 must still be
determined at a later stage of this case, it may be that the post-petition payments should be
considered to have been paid towards the secured claim. The specifics of what the debtor still
owes and what other remedies BLC2 may have for the alleged breach are reserved for another
day.
Solely the motion to allow an administrative expense claim in the full amount of BLC2’s claim is
DENIED. Any other issue arising out of this alleged breach was not adequately briefed and not
argued at all. As the prevailing party, the debtor should upload an order in accordance with this
ruling.
United States Bankruptcy Judge
DATED: August 16, 2010
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NOTE TO USERS OF THIS FORM:
1) Attach this form to the last page of a proposed Order or Judgment. Do not file as a separate document.
2) The title of the judgment or order and all service information must be filled in by the party lodging the order.
3) Category I. below: The United States trustee and case trustee (if any) will always be in this category.
4) Category II. below: List ONLY addresses for debtor (and attorney), movant (or attorney) and person/entity (or
attorney) who filed an opposition to the requested relief. DO NOT list an address if person/entity is listed in category I.
NOTICE OF ENTERED ORDER AND SERVICE LIST
Notice is given by the court that a judgment or order entitled (specify) MEMORANDUM OF DECISION
RE: BLC2’s MOTION FOR PAYMENT OF ADMINISTRATIVE CLAIM
was entered on the date indicated as AEntered@ on the first page of this judgment or order and will be served
in the manner indicated below:
I. SERVED BY THE COURT VIA NOTICE OF ELECTRONIC FILING (ANEF@) B Pursuant to controlling
General Order(s) and Local Bankruptcy Rule(s), the foregoing document was served on the following
person(s) by the court via NEF and hyperlink to the judgment or order. As of , the
following person(s) are currently on the Electronic Mail Notice List for this bankruptcy case or adversary
proceeding to receive NEF transmission at the email address(es) indicated below.
• Simon Aron saron@wrslawyers.com
• Theresa W Bangert tbangert@sheppardmullin.com
• Manuel A Boigues bankruptcycourtnotices@unioncounsel.net
• J Scott Bovitz bovitz@bovitz-spitzer.com
• Katherine Bunker kate.bunker@usdoj.gov
• Young K Chang bklaw3@yahoo.com
• Kathryn F Evans kevans@klehr.com
• Brian D Fittipaldi brian.fittipaldi@usdoj.gov
• Jeffrey K Garfinkle bkgroup@buchalter.com, jgarfinkle@buchalter.com
• Paul R. Glassman glassmanp@gtlaw.com
• Matthew A Gold courts@argopartners.net
• Michael I Gottfried mgottfried@lgbfirm.com, msaldana@lgbfirm.com
• Fredric J Greenblatt fjg@greenblattlaw.com
• Peter D Holbrook pholbrook@buchalter.com, amelanson@buchalter.com
• Brian L Holman b.holman@mpglaw.com
• Mark D Houle mark.houle@pillsburylaw.com
• Ivan L Kallick ikallick@manatt.com, ihernandez@manatt.com
• Andy Kong Kong.Andy@ArentFox.com
• John P Kreis jkreis@attglobal.net
• Mary D Lane mlane@pszjlaw.com
• George C Lazar glazar@foxjohns.com
• Scott Lee slee@lbbslaw.com
• Samuel R Maizel smaizel@pszjlaw.com, smaizel@pszjlaw.com
• John B Marcin jbm@marcin.com
• Craig G Margulies cmargulies@margulies-law.com
• Elissa Miller emiller@sulmeyerlaw.com, asokolowski@sulmeyerlaw.com
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• Alan I Nahmias anahmias@mbnlawyers.com, jdale@mirmanbubman.com
• David L. Neale dln@lnbrb.com
• Christopher R Nelson cnelson@erlaw.com
• Scott H Noskin snoskin@mbnlawyers.com,
krose@mbnlawyers.com;amcdow@mbnlawyers.com
• Aram Ordubegian ordubegian.aram@arentfox.com
• Richard Park Richard.Park@usdoj.gov
• Neil M Peretz neil.peretz@usdoj.gov
• Robert N Phan rphan@garciaphan.com
• Steven G Polard spolard@perkinscoie.com
• Thomas H Prouty thomas.prouty@troutmansanders.com, tina.diego@troutmansanders.com
• Christian L Raisner bankruptcycourtnotices@unioncounsel.net, craisner@unioncounsel.net
• Holly Roark holly@roarklawoffices.com
• Scott A Schiff sas@soukup-schiff.com
• Nathan A Schultz schultzn@gtlaw.com
• Steven A Schwaber schwaberlaw@sbcglobal.net, sasecf@gmail.com
• Benjamin Seigel bseigel@buchalter.com, IFS_filing@buchalter.com
• Seth B Shapiro seth.shapiro@usdoj.gov
• Eric J Siegler erics123@aol.com
• Adam M Starr starra@gtlaw.com
• Derrick Talerico dtalerico@loeb.com, kpresson@loeb.com;ljurich@loeb.com
• United States Trustee (SV) ustpregion16.wh.ecf@usdoj.gov
• Annie Verdries verdries@lbbslaw.com
• Ryan T Waggoner rwaggoner@erlaw.com
• Michael H Weiss mweiss@fms-law.com, lm@weissandspees.com;jb@weissandspees.com
• Michael H Weiss mw@weissandspees.com, lm@weissandspees.com;jb@weissandspees.com
Service information continued on attached page
II. SERVED BY THE COURT VIA U.S. MAIL: A copy of this notice and a true copy of this judgment or order
was sent by U.S. Mail to the following person(s) and/or entity(ies) at the address(es) indicated below:
Service information continued on attached page
III. TO BE SERVED BY THE LODGING PARTY: Within 72 hours after receipt of a copy of this judgment or
order which bears an AEntered@ stamp, the party lodging the judgment or order will serve a complete copy
bearing an AEntered@ stamp by U.S. Mail, overnight mail, facsimile transmission or email and file a proof of
service of the entered order on the following person(s) and/or entity(ies) at the address(es), facsimile
transmission number(s) and/or email address(es) indicated below:
Service information continued on attached page
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