By Ryan C. Wood
This is a common question when an owner of a strip-mall or large real property owner seeks bankruptcy protection under the Bankruptcy Code. There could be many unexpired lease agreements that must be dealt with in the bankruptcy case. What happens depends upon whether the bankruptcy case is a liquidation case or reorganization case. For our purposes we will assume the bankruptcy case is a reorganization under Chapter 11, 12 or 13 of the Bankruptcy Code. That means the individual or business is reorganizing their debts and obligations to continue to do business.
In the case we will be discussing, Erik Samuel De Jong; Daryl Lynn De Jong v. JLE-04 Parker, LLC; and the land at issue was land with the lease used to operate a dairy. A company called Sonora Desert owned three parcels of land and was a debtor under Chapter 11 of the Code at the time the Jong’s executed a three year lease with Sonora Desert. The terms were $30,000 a month for three years with a renewal clause. The Managing Member of Sonora Desert, Robert Lueck, advised the Jong’s that the lease agreement would have to be approved by the Bankruptcy Court. The Jong’s ignored Lueck and moved 1649 cows onto the lease property only one day after signing the lease. A few days later the Jong’s and Lueck executed a new lease that was more specific regarding the status of the property and the Jong’s rights. The new lease had new terms providing the lease could be terminated by either party with 180 days written notice to the other party. The lease also said the property was being marketed by Lueck for sale and that the Jong’s lease was in second position to the first priority deed of trust held by a creditor named Agstar and also a replacement second priority lien held by Wells Fargo.
Lueck sent the debtors a notice that their lease was being terminated according to the terms of the lease. At this time a trustee’s sale was scheduled for the property for December 6, 2013. JLE-04 Parker, LLC, purchased the dairy’s through the foreclosure sale auction. Except the Jong’s had no intention of leaving the property with their livestock any time soon. At some point the Jongs’ retained a bankruptcy attorney and filed for bankruptcy protection too.
In a normal bankruptcy case a lease can either be assumed or rejected. Lease or unexpired contracts are listed in Schedule G. In a reorganization case the bankruptcy filer normally initially chooses to either assume or reject a lease with months or years still left on the lease. If the lease is beneficial to the reorganization and success of the business it will be assumed. If not, the lease will be shed for the benefit of the reorganization. In this case the Debtor or bankruptcy filer had a lease with a third party, the Jongs’. For whatever reason the Debtor no longer wanted to do business with the Jongs’ and sent them notice of termination of the lease before filing for bankruptcy. If not, then the bankruptcy case would have governed the lease. In this case the tenancy of the Jongs’ was already terminated at the time the bankruptcy case was filed. But the Jongs continued to use the property after the bankruptcy case was filed to the detriment of the new owner JLE.
In this case the prepetition foreclosure sale of the real property subject to the alleged leasehold extinguished any leasehold interest or any other interest the Jong’s may have had in the dairy properties. If there were no foreclosure sale then the Debtor would choose to assume or reject the leases.
So the new owner of the dairy properties then filed an unlawful detainer against the Jong’s to forcibly remove them from the property in Arizona State Court.
The Jong’s are arguably a holdover tenant now and that is why the new owner of the properties from the foreclosure sale JLE wants them out. Their bankruptcy attorney probably told them you will lose money if you leave the property so just holdover until you sell your cows and then settle with JLE from the profits….. Ultimately JLE filed a proof of claim in the Jong’s bankruptcy case totaling $8,863,250 in damages for restitution and disgorgement of profits from the Jong’s improper use of the dairy property. The lower Bankruptcy Court held JLE had a prepetition claim for $558,716.24 and a post-petition administrative claim for $1,517,069.64. The Jongs’ then appealed. The Ninth Circuit Bankruptcy Appellate Panel reversed and remanded for the recalculation of JLE’s damages.
The Jongs’ leasehold was terminated by the foreclosure sale and then they continued to remain on the property. At some point the Bankruptcy Court held a hearing on the debtor’s damages for the Jongs’ continued and willful trespass. When a trespasser’s conduct is intentional and willful the liability can be measured by the trespasser’s benefit or profit from the trespass. See Restatement of Restitution Sections 40 and 51(4). In this case the proper measure is the benefit the Jongs received or the net profits they received from their wrongful use of JLE’s dairy property. In calculating the net profits normal business expenses are deducted from the gross revenue to determine the taxable income. This taxable income is the profits that need to be calculated. In this case the 9th Cir. BAP held the lower Bankruptcy Court erred in calculating the deductions for business expenses. The Debtors successfully argued the Bankruptcy Court double counted an expense.