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Rubloff Development Group, Inc. v. Kmart Corp.

April 23, 2008

RUBLOFF DEVELOPMENT GROUP, INC., APPELLANT,
v.
KMART CORPORATION, APPELLEE.



The opinion of the court was delivered by: John F. Grady, United States District Judge

MEMORANDUM OPINION

This case is before us on appeal from Bankruptcy Judge Sonderby's Findings of Fact and Conclusions of Law and related Order of November 20, 2007, which resolved Rubloff's eight claims in the bankruptcy reorganization of Kmart Corporation ("Kmart") relating to subleases for eight Kmart stores. For the reasons explained below, the order of the bankruptcy court is affirmed.

BACKGROUND

In the 1990s, Kmart Corporation("Kmart") was a tenant under certain long-term leases of commercial property for its retail stores (the "Master Leases"). Prior to filing its bankruptcy petition, Kmart closed the stores and vacated the premises. To reduce its losses, Kmart decided to sublease the properties. Between October 1998 and July 2000, Kmart subleased thirteen properties to Rubloff Development Group, Inc. ("Rubloff") pursuant to individual subleases (the "Subleases") for lower rents than Kmart was obligated to pay its landlords under the Master Leases. Eight of the properties, which are located in Illinois and Michigan, are involved in this dispute. After subleasing the properties from Kmart, Rubloff in turn sub-subleased them to various regional and national retailers. In connection with the sub-subleases, Rubloff renovated and made improvements to the properties, funding the renovations through subleasehold mortgage loans on its interest as subtenant.

On January 22, 2002, Kmart filed a voluntary petition for reorganization pursuant to Chapter 11 of the United States Bankruptcy Code. Kmart also filed a motion to reject more than three hundred leases and subleases, including the Master Leases and Subleases (the "Rejection Motion"). Schedule A to the Rejection Motion identified those leases and subleases as to which Kmart sought immediate rejection. Six of the Master Leases (and the corresponding Subleases) at issue here were on Schedule A.*fn1 Schedule B identified other leases and subleases that were slated for rejection upon notice by Kmart to the affected parties. Kmart reserved the right "not to reject" leases and subleases listed on Schedule B "and, therefore, not to send a Rejection Notice" so that Kmart still had the option of assuming and assigning those agreements. (Rejection Mot., R. 2.)

Almost immediately upon its receipt of the Rejection Motion, Rubloff began negotiating with Kmart in order to avoid the rejection of the Master Leases. In a number of communications, Kmart told Rubloff that based on its real estate advisor's analysis, Kmart would reject the Master Leases and Subleases unless a satisfactory agreement to assume and assign them was reached.

Rubloff was concerned that in the event of rejection, it would lose the Subleases, thereby causing it to default on its obligations under the sub-subleases. Rubloff also feared exposure to sub-subtenant claims for lost profits and reimbursement of expenses for improvement of the properties. Therefore, Rubloff asked Kmart to move the Master Leases and Subleases from Schedule A to Schedule B so that Rubloff would have an opportunity to negotiate an assignment. Kmart would not agree to move the contracts from one schedule to the other unless Rubloff agreed to assume all of the contractual liabilities under the Master Leases through either the date of assumption or the date of rejection. Although Rubloff felt pressured because of what it calls Kmart's "shotgun negotiations," Rubloff agreed to these conditions. Further negotiation ensued, and on January 24, 2002, Kmart and Rubloff reached an agreement providing for Kmart's assumption of the Master Leases and subsequent assignment of its interests in those leases to Rubloff.

By January 25, 2002, as a result of its negotiations and agreement with Rubloff, Kmart amended its schedules so that the Master Leases and Subleases appeared on Schedule B. The same day, Bankruptcy Judge Sonderby entered an order granting the relief Kmart sought (the "Rejection Order"). The Rejection Order provided as follows in pertinent part:

The rejection of the Real Property Leases shall be effective for each Real Property Lease set forth on the annexed Schedule A as of the date the Motion was filed, unless the applicable lessor objects, on any ground recognized under the Bankruptcy Code, within ten days of service of this Order on such lessor. In the absence of a timely objection or if an objection is overruled, the effective date of the rejection of a Real Property Lease set forth on the annexed Schedule A shall be as provided in the previous sentence. The rejection of the Real Property Leases shall be effective for each Real Property Lease set forth on the annexed Schedule B as of ten days following the delivery by the Debtors to the statutory committee and (or 20 largest creditors, if no committee has yet been formed) and the lessor under that particular Real Property Lease of a notice of rejection of that particular Real Property Lease. (Rejection Order, R. 3, at 2.)

Kmart never sent a notice of rejection of the Master Leases or Subleases. Instead, on February 1, 2002, Kmart and Rubloff executed the Lease Assignment and Assumption Agreement (the "Assignment Agreement"), pursuant to which Rubloff assumed all of Kmart's obligations under the "Leases," as defined in the Assignment Agreement, subject to the bankruptcy court's approval.

Shortly thereafter, Kmart filed a motion seeking the court's approval, stating that the estate would avoid significant rejection claims by assumption and assignment of the leases. After a hearing, the bankruptcy court entered a series of orders from February through July 2002 approving the assumptions and assignments. At the time the orders were entered, Kmart was current on its rent payments under the Master Leases and was also fulfilling its obligation under the Subleases to provide Rubloff with possession of the properties.

On July 29, 2002, Rubloff filed eight Proofs of Claim (the "Claims") in Kmart's bankruptcy proceedings, seeking a total of $28,660,212.21, which represented the difference between the rents now payable by Rubloff under the Master Leases and the rents that were originally payable by Rubloff under the Subleases (the "Spread Amount"). The Claims were based on contract. Kmart filed its objections to the Claims, and Rubloff responded. Subsequently, the parties filed cross-motions for summary judgment with respect to the Claims.

Rubloff contended that Kmart's filing of the Rejection Motion, along with its communications to Rubloff that the Master Leases were going to be rejected, demonstrated Kmart's intent not to perform its obligations under the Subleases. According to Rubloff, Kmart's actions constituted anticipatory repudiation of the Subleases; Rubloff was damaged by this breach to the extent that it lost the Spread Amount; and it entered into the Assignment Agreement in order to mitigate its damages. In response, Kmart did not dispute that if it had rejected the Master Leases and Subleases, Rubloff's claims against the estate would have exceeded the Spread Amount. But Kmart denied that it had anticipatorily repudiated the Subleases and asserted that even if it had, Rubloff had released any claim to the Spread Amount by the terms of the Subleases and Assignment Agreement.

After briefing and argument, Bankruptcy Judge Sonderby denied both parties' motions and found that certain issues of fact remained to be resolved. (Tr. of Oral Ruling, Dec. 6, 2006, R. 8.) A trial was held on the Claims in May 2007. On November 20, 2007, Bankruptcy Judge Sonderby issued a detailed written opinion titled "Findings of Fact and Conclusions of Law," In re Kmart Corp., No. 02 B 2474, 2007 WL 4556991 (Bankr. N.D. Ill.) (R. 22 ).*fn2 Judge Sonderby held that § 365 of the Bankruptcy Code, which gives a debtor-in-possession the power to decide whether to assume or reject a lease, qualifies the ability of Rubloff to use the anticipatory repudiation theory to recover from the bankruptcy estate in these circumstances. The bankruptcy court explained that application of the theory here would render § 365 meaningless. Id. at *8. The bankruptcy court also held that because § 365 requires court approval before a rejection can become effective, "no matter how unequivocal a debtor in possession's statements are prior to the rejection becoming effective, those statements are effectively rendered equivocal." ...


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