Michael H. Clement Corporation

4:09-bk-43502CanbOct 14, 2009

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UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re 	No. 09-43502 T
Chapter 11
MICHAEL H. CLEMENT CORPORATION,
Debtor-in-Possession.
_______________________________/
MEMORANDUM OF DECISION
The 	motion 	of 	Frank 	C. 	Alegre, 	Sr. 	and 	Helen 	C. 	Alegre 	as
Trustees of the Frank C. Alegre and Helen C. Alegre Revocable Trust
(hereinafter “Alegre”) for an order deeming a nonresidential lease of
real 	property 	rejected 	due 	to 	the 	debtor’s 	failure 	to 	assume 	it
within the time required by 11 U.S.C. § 365(d)(4) and for surrender
of 	the 	leased 	premises 	came 	before 	the 	Court 	on 	October 	5, 	2009.
Appearances 	were 	stated 	on 	the 	record. 	At 	the 	conclusion 	of 	the
hearing, the Court took the motion under submission. 	The Court has
now 	fully 	considered 	the 	evidence 	presented 	and 	the 	argument 	made.
Its findings and conclusions are set forth below.
SUMMARY OF FACTS
The above-captioned debtor (the “Debtor”) purchased certain real
property 	located 	at 	3500 	Wilbur 	Avenue, 	Antioch, 	California 	(the
Signed: October 14, 2009
________________________________________
LESLIE TCHAIKOVSKY
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
October 15, 2009
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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“Wilbur 	Avenue 	Property”) 	in 	1985. 	The 	Debtor 	is 	a 	licensed
contractor and manufacturing company and operates its business on the
Wilbur 	Avenue 	Property. 	Michael 	H. 	Clement 	(“Clement”), 	the
president 	and 	sole 	shareholder 	of 	the 	Debtor, 	and 	his 	family 	also
reside on the Wilbur Avenue Property.
On 	January 	12, 	2001, 	the 	Debtor 	entered 	into 	an 	agreement 	to
sell the Wilbur Avenue Property to Alegre for $1.3 million (the “Sale
Agreement”). 	Close of escrow was scheduled for October 31, 2001. 	As
a 	pre-condition 	to 	the 	close 	of 	escrow, 	Clement 	was 	required 	to
obtain certain entitlements for improvement of certain real property
located on Holland Tract Road in Knightsen, California (the “Holland
Tract 	Property”). 	Clement 	appears 	to 	have 	anticipated 	moving 	the
Debtor’s business operations to the Holland Tract Property when the
improvements 	were 	completed. 	Clement 	failed 	to 	obtain 	the
entitlements, 	and 	escrow 	did 	not 	close 	within 	the 	scheduled 	time.
The 	parties 	continued 	to 	negotiate 	and 	in 	2003 	entered 	into 	a
second 	agreement, 	entitled 	Rental 	and 	Development 	Agreement 	(the
“RDA”). 	The 	RDA 	recites 	that 	the 	Debtor 	and 	Clement 	will 	sell 	the
Wilbur Avenue Property to Alegre through a two-way Internal Revenue
Code Section 1031 exchange. 	(RDA, ¶(2)) Thereafter, the Debtor will
have the option to continue to occupy the Wilbur Avenue Property rent
free 	until 	thirty 	days 	after 	a 	certificate 	of 	occupancy 	has 	been
issued 	for 	the 	Holland 	Tract 	Property 	or 	an 	equivalent 	facility.
(RDA, ¶(5)) 	Alegre agrees to provide the funds to acquire and build
out 	the 	Holland 	Tract 	Property 	up 	to 	$1.3 	million. 	(RDA, 	¶(8)(c))
Title to the Wilbur Avenue Property is to be taken in Alegre’s name
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1The Debtor contends that the sale of the Wilbur Avenue
Property was never consummated and that it is still the owner of
the property. 	This contention is untenable. 	The Court has been
provided with a copy of the recorded deed transferring title to
Alegre. 	In addition, the complaint filed by the Debtor, seeking to
rescind the RDA, affirmatively alleges that sale escrow closed and
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pending 	completion 	of 	the 	Holland 	Tract 	Property 	project 	and 	1031
exchange. 	(RDA, ¶(10))
The 	RDA 	further 	provides 	that, 	in 	the 	event 	Alegre 	does 	not
complete 	the 	build 	out 	of 	the 	Holland 	Tract 	Property 	within 	two
years, 	the 	Debtor 	will 	have 	the 	option 	of 	buying 	back 	the 	Wilbur
Avenue 	Property 	for 	$1.3 	million 	less 	the 	commission 	paid 	by 	the
Debtor. 	(RDA, 	¶(12)) 	Alegre 	agrees 	that, 	over 	and 	above 	the 	$1.3
million to be spent on the acquisition and build out of the Holland
Tract 	Property, 	he 	will 	provide 	the 	Debtor 	and 	Clement 	with
additional product and services with a value of $104,000.
In 	the 	event 	the 	Holland 	Tract 	Property 	project 	has 	not 	been
completed 	within 	15 	months 	from 	the 	date 	of 	the 	RDA 	and 	the 	Debtor
wishes 	to 	continue 	to 	occupy 	the 	Wilbur 	Avenue 	Property, 	this
$104,000 obligation will be applied as a credit against rent, to be
calculated at $5,000 per month for months 16 through 24 and at $7,000
per month thereafter. 	When the credit is exhausted, the Debtor may
continue 	to 	occupy 	the 	space 	at 	a 	fair 	market 	value 	rent. 	(RDA,
¶(20))
The intended 1031 exchange was never accomplished. 	However, two
days 	after 	the 	RDA 	was 	executed, 	the 	Debtor 	executed 	a 	deed
transferring title to the Wilbur Avenue Property to Alegre, and the
deed was recorded. 1 	Alegre paid $1.3 million, less the commission,
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that Alegre is the owner of the Wilbur Avenue Property.
2The Debtor listed the Holland Tract Property as an asset on
Schedule A of its Schedules of Assets and Liabilities.
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to or on behalf of the Debtor in connection with the transaction. 	At
some point, the Debtor acquired title to the Holland Tract Property. 2
After 	executing 	the 	deed 	transferring 	title 	to 	Alegre, 	the 	Debtor
remained 	on 	the 	Wilbur 	Avenue 	Property, 	making 	no 	out-of-pocket
payment 	of 	rent. 	The 	$104,000 	in 	rent 	credit 	was 	exhausted 	in 	or
about 	May 	2006. 	The 	Debtor 	has 	remained 	on 	the 	Wilbur 	Avenue
Property since that time without paying rent.
In 	February 	2006, 	the 	Debtor 	and 	Clement 	sued 	Alegre 	in 	state
court, seeking, among other things, to rescind the sale of the Wilbur
Avenue Property to Alegre. 	Trial was set for May 2009. 	The Debtor
filed this bankruptcy case on April 28, 2009, presumably in the hope
of delaying the trial. 	This effort was unsuccessful, the trial took
place as scheduled, and judgment was rendered in July 2009 adversely
to the Debtor. 	A copy of the Statement of Decision has been provided
to 	the 	Court. 	In 	the 	Statement 	of 	Decision, 	the 	state 	court 	judge
holds that the Debtor cannot rescind the sale because it is unable to
repay 	Alegre 	for 	the 	approximately 	$1.3 	million 	sale 	price. 	In
August 	2009 	the 	Debtor 	filed 	a 	notice 	of 	appeal 	from 	the 	judgment,
and that appeal is pending.
The 	chapter 	11 	case 	has 	been 	pending 	for 	163 	days, 	and 	the
Debtor 	has 	not 	filed 	a 	motion 	to 	assume 	the 	lease 	of 	the 	Wilbur
Avenue Property or moved to extend the time for doing so.
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3Alegre notes that there are sublessees on the Wilbur Avenue
Property. 	He asserts that the sublessees must also vacate the
leased premises. 	He asserts that, under California law, sublessees
have no greater right to possession than the lessee, citing Syufy
Enterprises, L.P. v. City of Oakland, 104 Cal. App. 4 th 869, 882-
83, 887 (2002). 	The Debtor does not dispute these facts or this
legal proposition.
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DISCUSSION
Alegre’s argument is straightforward. 	He asserts that the lease
provisions 	of 	the 	RDA 	give 	rise 	to 	a 	nonresidential 	lease 	of 	the
Wilbur 	Avenue 	Property. 	Section 	365(d)(4) 	of 	the 	Bankruptcy 	Code
requires 	a 	chapter 	11 	trustee 	or 	debtor-in-possession 	to 	move 	to
assume or reject such a lease within 120 days of the petition date.
If 	the 	debtor-in-possession 	fails 	to 	act 	within 	the 	120 	days, 	the
lease is deemed rejected, and the leased property must be surrendered
to the landlord. 	More than 120 days have passed since the petition
was 	filed 	commencing 	this 	case. 	The 	Debtor 	has 	failed 	to 	move 	to
assume the lease. 	Therefore, the lease is deemed rejected, and the
Debtor 	is 	required 	to 	vacate 	the 	Wilbur 	Avenue 	Property. 3 	In 	any
event, 	Alegre 	argues, 	the 	Debtor 	is 	not 	entitled 	to 	remain 	on 	the
Wilbur Avenue Property without paying any rent.
The 	Debtor 	raises 	two 	arguments 	in 	opposition 	to 	the 	motion.
First, 	it 	contends 	that 	the 	Wilbur 	Avenue 	Property 	is 	residential
because Clement and his family live on the property. 	Therefore, it
is not subject to the 120 day deadline for assumption or rejection.
Second, 	it 	contends 	that, 	because 	the 	lease 	provisions 	are 	so
entangled 	with 	other 	provisions 	in 	the 	RDA, 	even 	if 	the 	lease 	is
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nonresidential, it does not constitute a bona fide lease. 	The Court
will address each argument in turn.
A. 	IS THE WILBUR AVENUE PROPERTY RESIDENTIAL OR NONRESIDENTIAL?
It is undisputed that the Wilbur Avenue Property is located in
a 	heavy 	industrial 	zone 	and 	cannot 	legally 	be 	used 	as 	a 	residence.
It 	is 	also 	undisputed 	that 	the 	primary 	use 	of 	the 	Wilbur 	Avenue
Property is commercial. 	Finally, it is also undisputed that Clement
and 	his 	family 	live 	in 	trailers 	on 	the 	Wilbur 	Avenue 	Property 	in
violation of the zoning law and have apparently done so for a lengthy
period 	of 	time. 	The 	question 	is 	whether, 	given 	these 	undisputed
facts, 	the 	Wilbur 	Avenue 	Property 	can 	fairly 	be 	characterized 	as
residential. 	The Court concludes that it cannot be.
The 	Debtor 	cites 	the 	following 	bankruptcy 	court 	decisions 	for
the proposition that real property is considered residential as long
as 	people 	reside 	on 	it: 	In 	re 	Independence 	Village, 	Inc., 	52 	B.R.
715 (Bankr. E.D. Mich. 1985); Secretary of the Army v. Terrace Apts.,
Ltd., 107 B.R. 382 (Bankr. N.D. Ga. 1989); In re Care Givers, Inc.,
113 	B.R. 	263 	(Bankr. 	N.D. 	Tex. 	1989); 	In 	re 	Lippman, 	122 	B.R. 	206
(Bankr. S.D. N.Y. 1990); In re Bonita Glen II, 152 B.R. 751 (Bankr.
S.D. Cal. 1993); In re Historical Locust St. Dev. Assocs., 246 B.R.
218 (Bankr. E.D. Penn. 2000). 	Alegre contends that these decisions
are all factually distinguishable and that the case with facts more
on 	point 	is 	Matter 	of 	Emory 	Properties, 	Ltd., 	106 	B.R. 	318 	(Bankr.
N.D. Ga. 1989). 	The Court agrees.
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26 4However, as discussed below, the agreement was found to be an
equitable mortgage rather than a lease. 	Therefore, the finding
that the real property was residential was dicta.
7
Independence Village involved the lease of a life-care facility
for 	the 	elderly. 	52 	B.R. 	at 	720-22. 4 	Terrace 	Apts. 	involved 	the
lease of low cost rental housing for military and civilian personnel
and 	their 	families. 	107 	B.R. 	at 	383-84. 	Care 	Givers 	involved 	six
leases 	of 	nursing 	homes. 	113 	B.R. 	at 	265-68. 	Lippman 	involved
leases of three apartments in a cooperative apartment building, one
of 	which 	the 	debtor 	and 	his 	daughter 	occupied, 	one 	of 	which 	was
sublet, and one of which was vacant. 	122 B.R. at 207. 	Bonita Glen
II 	involved 	the 	lease 	of 	real 	property 	upon 	which 	an 	apartment
building 	was 	to 	be 	built. 	152 	B.R. 	752. 	Historical 	Locust 	Street
Development 	involved 	the 	lease 	of 	real 	property 	to 	be 	used 	as 	a
parking lot in conjunction with a building containing 16 residential
units and four commercial units. 	246 B.R. at 220.
The 	distinction 	between 	the 	facts 	in 	these 	decisions 	and 	the
facts presented in the instant case is obvious. 	With the exception
of Historical Locust Street Development, it was the clear intent of
the leases that people would reside on the real property in question.
However, 	even 	Historical 	Locust 	Street 	Development 	does 	not 	supply
persuasive authority for finding the lease in this case residential
as the decision was not based on the fact that people resided on the
parking lot property.
By 	contrast, 	the 	facts 	in 	Emory 	Properties 	are 	much 	closer 	to
those 	presented 	here. 	In 	that 	case, 	the 	debtor 	operated 	a
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nonresidential hotel on the leased premises. 	The debtor argued that
the lease was residential because a few of the hotel employees lived
on 	the 	leased 	premises. 	The 	Emory 	Properties 	court 	rejected 	this
contention. 	106 B.R. at 320. 	Based on the authorities cited above,
the 	Court 	is 	not 	persuaded 	that 	the 	Wilbur 	Avenue 	Property 	can 	be
fairly 	characterized 	as 	residential 	simply 	because 	Clement 	and 	his
family live on it. 	Thus, the lease will be deemed rejected and
must be surrendered immediately unless the Court determines that it
is not a bona fide lease.
B. 	DOES THE RDA GIVE RISE TO A BONA FIDE LEASE?
As noted above, the Debtor also contends that the RDA does not
give 	rise 	to 	a 	bona 	fide 	lease 	as 	contemplated 	by 	11 	U.S.C. 	§
365(d)(3) and (4). 	It asserts that the provisions in the RDA for the
payment of rent are too intertwined with the other provisions of the
RDA 	for 	the 	lease 	provisions 	to 	qualify 	as 	a 	bona 	fide 	lease. 	In
support 	of 	this 	proposition, 	the 	Debtor 	relies 	primarily 	on 	In 	re
Moreggia & Sons, Inc., 852 F.2d 1179 (9 th Cir. 1988).
Moreggia 	involved 	the 	lease 	of 	two 	store 	units 	in 	the 	San
Francisco 	Produce 	Terminal 	by 	a 	seller 	of 	produce 	displaced 	by 	a
redevelopment 	project. 	The 	lease 	was 	for 	a 	total 	of 	50 	years,
including options. 	The lease term and rental rate was calculated by
the 	amount 	necessary 	to 	pay 	off 	the 	public 	bonds 	issued 	to 	finance
the 	construction 	of 	the 	Terminal. 	At 	the 	end 	of 	the 	50 	years, 	the
obligation 	to 	pay 	rent 	ceased. 	The 	chapter 	7 	trustee 	failed 	to
assume 	the 	lease 	within 	the 	deadline 	but 	later 	attempted 	to 	assume
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5The facts of Independence Village have been discussed in the
preceding section. PCH Associates involved a complex financing
scheme whereby the debtor, which owned a hotel in Philadelphia and
the land upon which the hotel sat, sold the land (but not the
hotel) and leased it back in order to raise funds to renovate the
hotel and to provide working capital. 	852 F.2d at 1183. 	The PCH
Associates court held that the lease was not a bona fide lease for
purposes of the Bankruptcy Code. 	804 F.2d at 198-99.
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and assign it to a third party. 	The lessor contended that the lease
was deemed rejected. 	The court disagreed.
The 	Moreggia 	court 	agreed 	with 	the 	lessor 	that 	the 	lease
qualified as a lease under state law. 	However, it concluded that not
every lease was subject to the automatic rejection provisions of 11
U.S.C. § 365(d)(4). 	It quoted a passage from the Senate Report to 11
U.S.C. 	§ 	506(b)(6), 	stating 	that 	references 	to 	leases 	of 	real
property 	applied 	only 	to 	bona 	fide 	leases 	and 	not 	to 	financing
leases. 	Id. at 1182. 	In support of this conclusion, it cited In re
Independence Village, 52 B.R. 715 (Bankr. E.D. Mich. 1985) and In re
PCH Associates, 804 F.2d 193 (2 nd Cir. 1986). 5
The Moreggia court concluded that the lease in question was the
product 	of 	“unique 	circumstances” 	and 	that 	no 	true 	landlord/tenant
relationship 	was 	ever 	intended 	or 	created. 	Therefore, 	the 	trustee
was not subject to the statutory deadlines for assumption set forth
in 11 U.S.C. § 365(d)(4). 	The court also found that the purposes of
§ 	365(d)(4) 	would 	not 	be 	served 	by 	applying 	its 	provisions 	to 	a
transaction 	of 	this 	sort. 	The 	court 	cited 	legislative 	history,
indicating that the statute had been enacted because of the concern
of 	Congress 	about 	the 	effect 	of 	tenant 	bankruptcies 	on 	shopping
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centers. 	Finally, 	the 	Moreggia 	court 	found 	that 	equitable
considerations argued against forfeiture of the debtor’s interest in
the property in question.
In a more recent case, however, the Ninth Circuit rejected the
“unique circumstances” argument. 	See In re George, 177 F.3d 885 (9 th
Cir. 	1999). 	In 	that 	case, 	in 	1987, 	the 	debtors 	entered 	into 	an
agreement 	with 	the 	City 	of 	Morro 	Bay 	for 	the 	lease 	of 	waterfront
property for a term of 30 years. 	The agreement required the debtors,
at 	their 	own 	expense, 	to 	construct 	and 	maintain 	pierage, 	docks,
quays, and restrooms for the benefit of the public. 	The debtors also
constructed commercial buildings for their own benefit. 	In 1994, the
debtors filed for chapter 11. 	When they failed to assume the lease
within the time required by 11 U.S.C. § 365(d)(4), the City filed a
motion 	for 	surrender 	of 	the 	property 	on 	the 	theory 	that 	the 	lease
should be deemed rejected.
In 	response, 	among 	other 	things, 	the 	debtors 	argued 	that 	the
lease 	was 	not 	a 	bona 	fide 	lease, 	relying 	on 	Moreggia. 	The 	George
court 	found 	the 	facts 	of 	the 	case 	before 	it 	distinguishable 	from
those in Moreggia. 	The court found it significant that the rent that
the debtors were required to pay to the City of Morro Bay was tied to
the fair market value of the property, not to financing requirements
for the development of the property.
The 	facts 	presented 	here 	fall 	somewhere 	in 	between 	those
presented 	in 	Moreggia 	and 	those 	presented 	in 	George. 	Clearly, 	the
RDA 	is 	not 	a 	financing 	lease. 	The 	rent 	to 	be 	paid 	was 	not 	tied 	to
the 	funds 	necessary 	acquire 	or 	develop 	the 	Wilbur 	Avenue 	Property.
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To 	the 	contrary, 	the 	RDA 	states 	that, 	after 	a 	specified 	period 	of
time, if the Debtor wishes to remain on the Wilbur Avenue Property,
the parties must agree on a fair market rate rent.
On 	the 	other 	hand, 	there 	is 	no 	fixed 	term 	for 	the 	lease.
Additionally, unlike any of the debtors in the cases which found the
leases to be subject to 11 U.S.C. § 365(d)(4), the Debtor owned the
Wilbur Avenue Property for many years before executing the RDA. 	The
RDA 	provisions 	give 	the 	Debtor 	the 	right 	to 	reacquire 	the 	Property
provided 	the 	sale 	price 	can 	be 	refunded. 	In 	any 	event, 	the 	Debtor
has the right to remain on the Property, apparently forever, provided
it can pay Alegre a fair rental rate.
In 	sum, 	although 	the 	question 	is 	a 	close 	one, 	the 	Court
concludes that the lease provisions of the RDA do not give rise to a
bona 	fide 	lease 	that 	is 	subject 	to 	the 	deadline 	for 	assumption 	or
rejection set forth in 11 U.S.C. § 365(d)(4). 	Therefore, the motion
for an order deeming the lease provisions of the RDA rejected and for
surrender of the Property will be denied.
However, 	the 	Court 	agrees 	with 	Alegre 	that 	the 	Debtor 	may 	not
continue 	to 	occupy 	the 	Property 	rent 	free. 	The 	Court 	directs 	the
parties 	to 	meet 	and 	confer 	within 	the 	next 	two 	weeks 	to 	attempt 	to
agree on a fair rental rate. 	In the event the parties cannot agree,
Alegre 	is 	directed 	to 	file 	a 	motion 	for 	the 	determination 	of 	an
appropriate rental rate with supporting evidence. 	Once the rate is
determined, the debtor will be required to pay the rent on a current
basis 	in 	order 	to 	remain 	on 	the 	property. 	Counsel 	for 	Alegre 	is
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directed to submit a proposed form of order in accordance with this
decision.
END OF DOCUMENT
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COURT SERVICE LIST
James A. Tiemstra
Law Offices of James A. Tiemstra
Tribune Tower
409 13th St. 15th Fl
Oakland, CA 94612
Jermeny W. Katz
Pinnacle Law Group
425 California St., Ste. 1800
San Francisco, CA 94104
Steven B. Piser
Law Offices of Steven B. Piser
499 Fourteenth St., Ste. 210
Oakland, CA 94612
Case: 09-43502 Doc# 80 Filed: 10/14/09 Entered: 10/15/09 12:46:31 Page 13 of
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