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IN RE KMART CORPORATION

August 27, 2003

IN RE KMART CORPORATION, ET AL., DEBTORS; SHANRI HOLDINGS CORP., APPELLANT,
v.
KMART CORPORATION, APPELLEE



The opinion of the court was delivered by: Robert Gettleman, District Judge

MEMORANDOM OPINION AND ORDER

This matter is before the court on appeal from a dismissal by the bankruptcy court, with prejudice, for failure to state a claim upon which relief could be granted. For the reasons stated herein, the instant case is remanded to the bankruptcy court for action consistent with this opinion.

FACTS

On November 27, 1997, Shanri Holdings Corp. ("Shanri"), Kmart Corp. ("Kmart"), and Builders Square, Inc. entered into a "Termination of Lease and Settlement Agreement" (the "Settlement Agreement"), which settled pending litigation arising from Builders Square's rejection of its property lease with Shanri.*fn1 The Settlement Agreement, which is governed by Rhode Island law, specifically provided, among other things, that upon Shanri's satisfaction of certain conditions precedent, Kmart would pay Shanri $3,500,000. The $3,500,000 was secured [ Page 2]

by a letter of credit (the "letter of credit") issued by Chase Manhattan Bank (the "Bank") and payable to Shanri upon delivery of certificates executed by both Kmart and Shanri acknowledging that the conditions precedent were satisfied.

After Kmart filed for bankruptcy, Shanri satisfied the conditions precedent and requested that Kmart sign a certification acknowledging that those conditions had occurred, so that Shanri could draw on its letter of credit. Although it is undisputed that Shanri satisfied the conditions precedent, Kmart refused to sign the certification. This prompted Shanri to institute an adversary proceeding in the Bankruptcy Court seeking specific performance of Kmart's obligation to sign the certification.

According to the parties' joint stipulation of facts,*fn2 as of the date of Kmart's bankruptcy petition, the Bank was an undersecured creditor of Kmart, Under Kmart's First Amended Joint Plan of Reorganization, dated February 25, 2003, almost all of the unsecured creditors "will receive their pro rata share of 31,945,161 shares of common stock in reorganized Kmart," which "represents approximately 37% of all such common stock to be issued under the Plan." Notably, however, Section 5,3 of Kmart's First Amended Joint Plan of Reorganization provides, in pertinent part:

In addition, with respect to each letter of credit outstanding under the Prepetition Credit Agreements as of February 20, 2003, the Reorganized Debtors shall, as soon as practicable after the Effective Date, (i) obtain a replacement letter of credit, (ii) provide cash collateral equal to 105% of the face amount of the letter of credit, or (iii) if such letter of credit has been drawn, reimburse the Prepetition Lenders (or issuing bank, as [ Page 3]
applicable) with respect to such drawn letter of credit in full in Cash on the Effective Date.
Thus, on May 6, 2003, pursuant to Section 5.3, reorganized Kmart cash collateralized the $3.5 million Shanri letter of credit at 105% plus fees, which means that, if Shanri draws on the letter of credit, the Bank will collect $3.5 million (plus any taxes and reasonable fees and costs the Bank incurs in connection with the payment of the letter of credit) of reorganized Kmart's assets.

In an oral ruling on November 26, 2002, the bankruptcy court dismissed Shanri's adversary proceeding under Fed.R. Civ. P, 12(b)(6) for failure to state a claim upon which relief could be granted, concluding that Shanri had a "claim" as defined by Section 101(5) of the Bankruptcy Code, 11 U.S.C. § 101(5), that was subject to the claims administration process.

DISCUSSION

The court has jurisdiction to hear the instant appeal under 28 U.S.C, § 158(a)(1), which provides that "[t]he district courts of the United States shall have jurisdiction to hear appeals (1) from final judgments, orders and decrees . . . of bankruptcy judges entered in cases and proceedings referred to the bankruptcy judges under section 157 of this title." On appeal, the bankruptcy court's rulings and conclusions of law are reviewed de novo, Meyer v. Rigdon, 36 F.3d 1375, 1378 (7th Cir. 1994), and its findings of fact shall not be set aside unless they are clearly erroneous. Fed, R. Bankr. P. 8013.

The central issue on appeal is whether Shanri's adversary suit seeking the equitable remedy of specific performance qualifies as a "claim" under the Bankruptcy Code that should be [ Page 4]

liquidated in the claims allowance process, rather than tried as an adversary proceeding. Section 101(5) defines a "claim" as;

(A) a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or
(B) a right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.
...

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