Contributed by Dana Hall
The United States Court of Appeals for the Third Circuit recently held that the United States Bankruptcy Court for the District of Delaware did not err in reopening two reorganized debtors’ chapter 11 cases to determine the validity of a purchase option in a lease. The Third Circuit, in so doing, overturned a decision by the United States District Court for the District of Delaware, which had vacated the bankruptcy court’s order on the basis that it constituted an advisory opinion. We previously blogged about the district court decision here. The Third Circuit also held, in a case of first impression for that circuit, that a party seeking to reopen a debtor’s bankruptcy case may proceed by filing a motion and need not commence an adversary proceeding.
Prior to commencing its chapter 11 case, Lazy Days’ R.V. Center, Inc. entered into a settlement with one its lessors permitting it to assign its lease to a debtor affiliate, LDRV Holdings Corp. During its chapter 11 case, Lazy Days assumed the settlement agreement and assumed and assigned the lease to LDRV. After both debtors had emerged from chapter 11 and their cases had been closed, LDRV attempted to exercise a purchase option contained in the assigned lease. The lessor opposed LDRV’s attempts to exercise the purchase option on the basis that the option was, by its own terms, effective only to the extent that the lease had not been assigned. The parties commenced litigation in Florida state court to determine their rights under the lease, and the two reorganized debtors simultaneously moved the bankruptcy court to reopen their cases to determine that the purchase option restriction constituted an unenforceable anti-assignment provision pursuant to section 365(f)(3) of the Bankruptcy Code. The bankruptcy court, following extensive briefing and oral argument, held that the anti-assignment provision was unenforceable and that the lessor’s refusal to honor the purchase option violated the terms of the assumed settlement agreement. On appeal, the district court, in a relatively short opinion, held that the bankruptcy court had abused its discretion by issuing an advisory opinion. The district court found it “crystal clear” that the reorganized debtors had only sought an opinion from the bankruptcy court for the purpose of instructing the state court proceedings.
On review, the Third Circuit disagreed with the district court and found, among other things, that the bankruptcy court’s order was not an advisory opinion because it “affected the rights of [the] litigants.” The court cited Chafin v. Chafin, a U.S. Supreme Court decision in which the Supreme Court held that federal courts could not decide questions that do not affect the rights of litigants in the case or give opinions advising what the law should be based upon a hypothetical set of facts. The Third Circuit held, however, that because the bankruptcy court opinion invalidated an anti-assignment clause contained in the disputed lease and ordered the parties to honor the purchase option contained in that lease, the bankruptcy court’s opinion did not constitute an advisory opinion. The court also found that the reliance by the district court and the appellee-lessor on In re Martin’s Aquarium was misplaced. In Martin’s Aquarium, a bankruptcy court reopened a debtor’s case for the limited purpose of ruling that an earlier stipulation and order entered in the debtor’s chapter 7 case constituted a judgment within the meaning of Federal Rule of Civil Procedure 54(a). The ruling, however, did nothing to resolve the parties’ state court dispute or determine whether the state court would be required to abide by the judgment under state law. In Lazy Days, on the other hand, the bankruptcy court’s order had the legal effect of voiding the anti-assignment clause in the lease and, therefore, did not constitute an advisory opinion. Accordingly, as a result of the Lazy Days decision, a bankruptcy court sitting in the Third Circuit will not likely consider an opinion “advisory” if it has some bearing on or affects the parties’ legal rights.
In an issue of first impression in the Third Circuit, the court also ruled that a party need not initiate an adversary proceeding to reopen a bankruptcy case. Bankruptcy Rule 7001 provides that “a proceeding to determine the validity, priority, or extent of a lien or other interest in property” is an adversary proceeding and is subject to the procedures set forth in Part VII of the Bankruptcy Rules. The appellee in Lazy Days argued that, in light of Bankruptcy Rule 7001, the motion to reopen constituted an adversary proceeding and that the appellee was denied due process because the bankruptcy court did not apply the procedural rules applicable to adversary proceedings. The Third Circuit, however, disagreed and held that the rules governing adversary proceedings did not apply because the bankruptcy court “was only adjudicating a motion to reopen in order to interpret and enforce its existing prior order.”