Opinion
BKY No. 02-82361, Adv. No. 03-4174, Civil No. 04-1353 (JRT).
August 27, 2004
Scott Allen Johnson, JOHNSON LAW GROUP, Minnesota, MN, for James Bartholomew, as Trustee for the Liquidating Trust of Tricord Systems, Inc., debtor.
Paul Laurin Ratelle and Michael A. Rosow, FABYANSKE WESTRA HART, Minneapolis, MN, for defendant General Electric Capital Corporation.
Phillip W. Bohl and William J. Fisher, GRAY PLANT MOOTY MOOTY BENNETT, Minneapolis, MN, for defendant Adaptec, Inc.
MEMORANDUM OPINION AND ORDER AFFIRMING IN PART AND REVERSING IN PART THE ORDERS OF THE BANKRUPTCY JUDGE
This action presents cross-appeals of James Bartholomew, appointed liquidation trustee for the estate of Tricord Systems, Inc. ("Tricord" or "plaintiff"), General Electric Capital Corporation ("GECC"), and Adaptec, Inc. ("Adaptec"). After a short trial, United States Bankruptcy Judge Robert J. Kressel entered judgment in favor of Tricord. Though judgment was entered in Tricord's favor, the parties disagree on the record and specific rulings of the bankruptcy court, as will be discussed below. In this appeal, the parties raise a multitude of issues. In sum, Tricord argues that the bankruptcy court erred by refusing to allow Tricord to prevail on its strongest theories; Tricord suggests this Court should affirm, but provides alternate grounds for the Court to do so. Adaptec urges reversal arguing the bankruptcy court erred as a matter of law in finding for Tricord on an "unjust enrichment" theory; Adaptec also argues that the judgment cannot be affirmed on a subrogation theory (though the parties dispute whether the bankruptcy court ultimately found for Tricord on such a theory). GECC argues that the judgment should be reversed for several reasons, including that the bankruptcy court's decision on the breach of contract claim was contrary to law and not supported by the evidence. For the reasons discussed below, the judgment for Tricord and against Adaptec is affirmed, the judgment for Tricord and against GECC is reversed, and the matter is remanded for further proceedings not inconsistent with this opinion.
The Court will discuss below whether there is any basis on which to find that the bankruptcy court's partial summary judgment order in favor of plaintiff and against Adaptec on a subrogation theory was modified.
BACKGROUND
I. Factual BackgroundIn early February 2001, Tricord and GECC entered into a Master Lease Agreement ("the lease") by which GECC leased two telephone systems to Tricord. One of the telephone systems related to equipment for use in Minnesota and the other system related to equipment for use in Colorado. The lease provided that Tricord was to make 60 monthly installments of $3,673.99 and provided that, at the expiration of the lease term, Tricord could opt to purchase the equipment at the installed fair market value.
Pursuant to the lease and prior to the commencement of the Chapter 11 bankruptcy case, Tricord obtained an irrevocable, "evergreen" letter of credit ("LOC"), issued by Wells Fargo, N.A. ("Wells Fargo"). According to the terms of the LOC, "failure to comply with the provisions of this Section shall constitute an Event of Default . . . entitling Lessor to exercise its remedies pursuant to Section 15 [and to] draw all amounts available under the LOC but in no event more than an amount equal to Lessor's Loss." (GECC's Appendix ("Ap.") at 7.) The LOC provided that it would be renewed automatically unless Wells Fargo gave notice of nonrenewal. On August 19, 2002, Wells Fargo provided such notice of nonrenewal. Tricord took no action to obtain a renewal of the LOC from Wells Fargo or to obtain a replacement LOC.
In October 2002, Tricord negotiated and executed an asset purchase agreement with defendant Adaptec. Included in the asset purchase agreement was the Lease between Tricord and GECC. The Asset Purchase Agreement specified that the closing date of the transaction would be two days after the bankruptcy court entered its Order confirming the sale. The bankruptcy court held a hearing on the sale on November 13, 2002 and entered an order that same day approving the sale. The sale closed according to the Asset Purchase Agreement on November 15, 2002, and the telephone equipment that was the subject of the lease was delivered to Adaptec. Adaptec remains in possession of the telephone equipment. Although the asset purchase agreement included the lease, Adaptec did not renew the LOC pursuant to the terms of the lease.
After November 13, 2002, Tricord mailed payments to GECC for the months of October 2002 and November 2002 as applied on the Billing Schedule of Account.
On November 15, 2002, Wells Fargo paid GECC $194,237, honoring GECC's draw on the LOC which Wells Fargo received on November 13, 2002. GECC did not send a notice of default to Tricord prior to November 13, 2002.
On or about November 26, 2002, Wells Fargo filed a motion in the bankruptcy case for a hearing on December 12, 2002, seeking relief from the automatic stay of 11 U.S.C. § 362 in order to enforce its remedies under the Standby Letter of Credit Agreement. The motion was unopposed and the bankruptcy court granted relief from the stay on December 12, 2002.
II. Procedural History
The three parties brought cross-motions for summary judgment before the bankruptcy court, which held oral argument on January 6, 2004. In an order dated that same day, the bankruptcy court granted all three motions in part. Specifically, the bankruptcy court granted summary judgment to Tricord on its subrogation theory, though the bankruptcy judge reserved ruling on the amount to which Tricord was entitled, reasoning that such amount would be determined at trial. The court also held that "plaintiff shall recover nothing from the defendants on Counts I, II, III, and V of his complaint." (Order Dated Jan. 6, 2004, ¶ 2.) In other respects, the bankruptcy court denied the motions. ( Id. ¶ 4.)
Specifically, the order states, "The plaintiff is entitled to subrogation under Count VI of his complaint in an amount to be determined at trial." (Jan. 6, 2004 Order at ¶ 3).
A short trial was held on January 13, 2004, after which the matter was taken under advisement. In a Memorandum Order dated January 23, 2004, the bankruptcy court ruled in favor of Tricord and against GECC in Tricord's breach of contract claim. The Court also ruled in favor of Tricord and against Adaptec on a theory of unjust enrichment, awarding $170,310. The January 23 Memorandum Order did not address the subrogation theory on which the bankruptcy court had previously ordered summary judgment in plaintiff's favor.
The parties brought post-trial motions, and a hearing was held February 18, 2004. No additional written opinion was tendered, though the bankruptcy judge modified the judgment against GECC and in favor of Tricord from just over $200,000 to $198,530. plus appropriate pre-judgment interest. (See Transcript from Feb. 18, 2004 hearing at 12-13.)
The parties dispute several elements of the procedural history of this case. In particular, Adaptec and Tricord dispute whether the bankruptcy judge's partial summary judgment ruling was implicitly overruled. GECC and Tricord, for their part, dispute whether Tricord initially brought a motion for summary judgment against GECC in the bankruptcy court.
In sum, though the record is far from clear, it is plain that judgment was entered in favor of plaintiff and against Adaptec in the amount of $170,310 on an unjust enrichment theory. It is also plain that judgment was entered in favor of plaintiff and against defendant GECC in the amount of $198,530 plus interest on a theory of breach of contract.
ANALYSIS
I. Standard of Review
In bankruptcy proceedings, the District Court sits as an appellate court and applies the same standard of review as the Court of Appeals. Rampy v. Messerli, 224 B.R. 701, 704 (D. Minn. 1997) (citations omitted). The bankruptcy court's findings of fact are reviewed for clear error, while its conclusions of law are reviewed de novo. Id.; Fed.R.Bankr.P. 8013.
The Court notes that a district court sitting in review of the decision of a bankruptcy court can affirm the bankruptcy court's decision on any ground supported by the record. In re Slatkin, 310 B.R. 740, 744 (C.D. Cal 2004) (citing Padilla v. Terhune, 309 F.3d 614, 618 (9th Cir. 2002)); In re Sankey, 307 B.R. 674, 683 (D. Ala. 2004); see also Godfrey v. Pulitzer Publ'g Co., 276 F.3d 405, 409-10 (8th Cir. 2002) (stating that an appellate court may affirm "on any grounds supported by the record").
II. Adaptec
The judgment against Adaptec potentially rests on two grounds: unjust enrichment and subrogation. There is no dispute that judgment was entered on the unjust enrichment ground. Therefore, the Court will first address that basis for the decision. Because the Court finds that the judgment against Adaptec cannot be affirmed on that ground, the Court will then discuss whether the decision can be upheld on the subrogation ground or any other ground supported by the record.
A. Unjust Enrichment
As recently summarized by the Minnesota Court of Appeals: "To establish a claim for unjust enrichment, the claimant must show that another party knowingly received something of value to which he was not entitled and that the circumstances are such that it would be unjust for that person to retain the benefit." Mon Ray, Inc. v. Granite Re, Inc., 677 N.W.2d 434, 440 (Minn.Ct.App. 2004). Though illegal conduct is a viable basis for a claim of unjust enrichment, a party claiming unjust enrichment may premise his or her claim upon "failure of consideration, fraud, or mistake, or `situations where it would be morally wrong for one party to enrich himself at the expense of another.'" Id. (emphasis added) (quoting Holman v. CPT Corp., 457 N.W.2d 740, 745 (Minn.Ct.App. 1990) (additional citation omitted)).
Unjust enrichment, as an equitable remedy, comes into play only when the rights of the parties are not governed by a valid contract. U.S. Fire Ins. Co. v. Minn. State Zoological Bd., 307 N.W.2d 490, 497 (Minn. 1981) ("equitable relief cannot be granted where the rights of the parties are governed by a valid contract') (citing Cady v. Bush, 166 N.W.2d 358 (Minn. 1969)); Colangelo v. Norwest Mortg., Inc., 598 N.W.2d 14, 19 (Minn.Ct.App. 1999) ("[w]here the rights of the parties are governed by a valid contract, a claim for unjust enrichment must fail").
On appeal, Tricord does not dispute that its relationship with Adaptec was governed by the parties' asset purchase agreement. The Court therefore cannot affirm the bankruptcy court's judgment for Tricord and against Adaptec on Tricord's unjust enrichment theory.
B. Subrogation
Adaptec argues that the bankruptcy court's basis for the judgment against it rested solely on the unjust enrichment theory. Adaptec argues that the bankruptcy court's partial summary judgment order in which the court determined that Adaptec was liable to Tricord on a subrogation theory was later rejected by the bankruptcy court. Although it is clear that the bankruptcy court decided not to award damages to Tricord via the subrogation theory, it is far from clear that the bankruptcy court did so because it revisited its position on the subrogation issue. The January 23, 2004 Memorandum Order did not discuss the subrogation issue specifically. The order did note, however, that "I have previously granted partial summary judgment on various claims." (January 23 Memorandum Order at 3.) The bankruptcy court did not intimate that the partial summary judgment ruling was in any way impacted by the Memorandum Order.
Adaptec points to statements made during the hearing on the post-trial motions to support its position. Tricord made a post-trial motion to amend the judgment pursuant to Rule 59. Specifically, Tricord requested that the bankruptcy court quantify the amount of Tricord's loss under the subrogation theory. After a very short argument in which the parties addressed the amount of damages, the bankruptcy court denied the motion. The Court stated:
Well, I mean, I guess that is why summary judgment orders are interlocutory and not final and subject to being revisited to the extent that there is some inconsistency with whatever I did in the summary judgment order and the final judgment it is the final judgment that is governed, and I guess I feel that what I awarded the Plaintiff in the final judgment was what I thought the Plaintiff was entitled to under the theories that he presented and the theories that I analyzed and no more.
(Transcript of February 18, 2004 at Adaptec App. at 6.) ("Feb. 18 Trans.")
This Court is not persuaded that the bankruptcy court revised his summary judgment ruling. There was no motion before the bankruptcy court to amend its determination that Adaptec was liable on a subrogation theory. In fact, it appears that counsel for Adaptec reserved the right to appeal that portion of the partial summary judgment ruling. See Feb. 18 Trans. at Adaptec App. 5 (counsel for Adaptec, after discussing the evidence of damages, stating, "the trial record is not entirely clear about the dollar amounts, what I would submit, Your Honor, is that applying that measure of damages under a subrogation theory without, of course, waiving Adaptec's right to appeal on the underlying issue applied to the facts here . . .") (emphasis added). It appears instead that the bankruptcy court determined that he had ordered that plaintiff recover the sum to which he believed plaintiff was entitled from each party, and that no additional award of damages was necessary.
The Court can find no indication that the bankruptcy court rescinded its determination that plaintiff was entitled to partial summary judgment on a theory of subrogation. Therefore, the Court turns to a discussion of whether the judgment can be affirmed on that ground.
"Under the doctrine of equitable subrogation, `one who has been compelled to pay a debt which ought to have been paid by another is entitled to exercise all the remedies which the creditor possessed against that other.'" Mon Ray, 677 N.W.2d at 441 (citing Am. Sur. Co. of New York v. Bethlehem Nat. Bank of Bethlehem, Pa., 314 U.S. 314, 317 (1941)). A party claiming equitable subrogation must establish the following factors: (1) the payment was made by the subrogee to protect his own interests; (2) the subrogee did not act as a volunteer; (3) the debt paid must be one for which the subrogee was not primarily liable; (4) the entire debt must have been paid; and (5) subrogation must not work an injustice to the rights of others. In re: Photo Mech. Servs., Inc., 179 B.R. 604 (Bk. Minn. 1995).
Tricord argues that it satisfies the above elements, suggesting that when Tricord's Letter of Credit proceeds were drawn upon by GECC, Tricord became subrogated to the rights of Adaptec, who had agreed to satisfy GECC under its Equipment Lease claims. Tricord essentially asserts that Adaptec and Tricord agreed (among other things) that Adaptec would receive the telephone equipment in return for assuming the lease obligations. Adaptec received the benefit of the equipment, but escaped its obligations under the lease because GECC's draw on the letter of credit fully paid off the lease.
Adaptec counters (without conceding its argument that the bankruptcy court rescinded its subrogation holding) that plaintiff cannot establish the last three required elements. Specifically, Adaptec argues that on November 13, 2002, when GECC drew on the letter of credit, Tricord remained primarily liable for the debt. However, the Court notes that the payment actually was made on November 15, 2002, the day of the closing. As to the fourth and fifth elements, Adaptec argues that there was insufficient evidence of damages presented at trial to support a decision for plaintiff on the subrogation theory.
The main element in dispute, in the Court's view, is the third. That is, was there a basis on which to find that the debt paid was one for which the subrogee (Tricord) was not primarily liable. If Tricord was liable for the debt, subrogation will not lie. Matter of Robins Int'l, Inc. 275 B.R. 456, 471 (S.D.N.Y. 2002) ("It is well settled that one who makes a payment that is the primary obligation of the payor, as distinguished from a payment of the debt of another, is not entitled to subrogation."). However, "the relevant question in the subrogation context is not simply whether the party was directly liable, but rather whether its payment was used to satisfy another's obligation. The question is sometimes conceived as one of `ultimate' liability — a question that can be answered by determining which of the liable parties received the consideration." In re Wingspread Corp., et al., 145 B.R. 784, 790 (S.D.N.Y. 1992).
Resolution of this dispute requires an analysis of the parties' relationship and obligations on November 13-15, 2002, as well as a determination of which party received the consideration. The record reflects that two critical events occurred on November 13, 2002. One of those events was the bankruptcy court's approval of the assignment of the Lease to Adaptec. The other was GECC's draw on the LOC. The record does not reflect the order of those events. Payment was drawn, out of Tricord's funds, on November 15, 2002.
The standard articulated in the Wingspread Corp. decision is satisfied here. While it is debatable whether Tricord was primarily liable on November 13, Tricord clearly was not liable on November 15, 2002. Also clear is that Adaptec received the consideration — in the form of the telephone lease equipment — for the payment. The Court is satisfied that Tricord was not primarily liable for the debt, and Adaptec's argument that Tricord cannot satisfy this element of subrogation is not successful.
Adaptec further argues that the final two elements cannot be satisfied. The bankruptcy court, perhaps because of the award of full damages on the unjust enrichment theory, did not assess damages under the subrogation theory. Damages are more properly assessed by the trial court in the first instance, and this Court therefore remands for further proceedings not inconsistent with this opinion.
III. GECC
A. Specific Procedural Background
The parties dispute what relief plaintiff sought against GECC in the partial summary judgment proceeding. GECC suggests that plaintiff sought summary judgment only against Adaptec, and did not seek summary judgment on any of Tricord's claims against GECC. Plaintiff suggests, however, that it moved for summary judgment against GECC seeking a declaration that the automatic stay had been violated and GECC's draw on the Letter of Credit should be nullified. In reviewing the transcript of the oral argument on the cross-motions for summary judgment, as well as the appendices provided by the parties, the Court cannot find any indication in the record that plaintiff moved for summary judgment against GECC. With this background in mind, the Court turns to GECC's arguments.
B. Violation of Automatic Stay
The bankruptcy court ultimately determined that there was no violation of the automatic stay, because the LOC proceeds are not assets of the estate. (Transcript of Jan. 6, 2004 Motions Hearing at 24.) Plaintiff disputes this contention, and suggests that while LOC proceeds might not be property of the estate, the surplus — about $70,000 — was. Plaintiff argues that it has raised a question of material fact, creating a triable issue on whether GECC violated the automatic stay.
Bankruptcy law prohibits creditors from taking action to obtain "property of the estate" and also prevents action to "create, perfect or enforce [a] lien against property of the estate." 11 U.S.C. § 362. However, as the bankruptcy court recognized, it is well established that letters of credit are not property of a debtor's estate. (Transcript of Jan. 6, 2004 Motions Hearing at 24 "neither the letter of credit nor the proceeds of the letter of credit are property of Debtor or property of the estate in any way, and the cases going all the way back to Leisure Dynamics in this district say as much.")
Plaintiff attempts to draw a distinction between this instance, and those cases indicating that a letter of credit and its proceeds are not property of the debtor's estate by arguing that it is the surplus that is at issue here. Citing cases including the Eighth Circuit's decision in In re: Papio Keno Club, Inc., 262 F.3d 725, 731 (8th Cir. 2001), plaintiff argues that because GECC drew more than the "Lessor's Loss," GECC encroached into plaintiff's estate. The Court is not persuaded by plaintiff's argument or its analysis of the cited cases. At best, those cases stand for the proposition that the doctrine of independence will not preclude an action on the underlying contract between an applicant and the letter of credit beneficiary. In re Papio Keno Club, Inc., 262 F.3d at 731.
As will be discussed below, plaintiff might have a contract claim regarding the letter of credit proceeds, but the law is settled that letters of credit are not property of the debtor's estate. See Kemczyk v. Mutual Life Ins. Co. of New York, (in re Graham Square, Inc.), 126 F.3d 823, 827 (6th Cir. 1997) ("It is one thing to attempt to prevent the distribution of the proceeds of a letter of credit, an attempt the doctrine of independence is designed to prevent; but it is quite another to bring an action on the underlying contract that created the letter of credit."). The bankruptcy court's determination that there was no violation of the automatic stay is therefore affirmed.
C. Breach of Contract
As the Court discusses above, Tricord does not have a claim for violation of the automatic stay; nonetheless, these same facts do state a claim for breach of contract. The bankruptcy court concluded that Wells Fargo's notice of non-renewal was not an event of default under the lease or the addendum to the lease. (Jan. 23, 2004 Memorandum Order at 4.) Therefore, the bankruptcy court found GECC in breach of the lease agreement and assessed damages sufficient to put Tricord in the same position it would have been had the breach not occurred. ( Id.)
GECC argues that even if Tricord might once have had a breach of contract claim against GECC, when Tricord assigned its rights and interests under the lease to Adaptec, it did not reserve that claim. GECC argues all rights and obligations under the lease were transferred to Adaptec. The bankruptcy court did not discuss how the right to pursue a breach of contract action was reserved, and did not address the language of the transfer agreement.
GECC also argues that even if the right to pursue the breach claim had been reserved, GECC's draw on the LOC did not amount to a breach, because Tricord was in default for several reasons. GECC suggests that it had no obligation under the lease to give Tricord notice or an opportunity to cure for the specific defaults that had occurred. GECC enumerates numerous defaults, including (1) Tricord's insolvency (Section 14(g) of the Lease); (2) filing of a voluntary petition under the United States Bankruptcy Code (Section 14(g) of the Lease); (3) Tricord's assignment of the Lease without GE's prior written consent; (4) Tricord's dissolution or cessation of doing business as a going concern (Section 14(e) of the Lease); (5) Tricord's sale of all or substantially all of its assets (Section 14 (f) of the Lease).
The plain language of the LOC Addendum permits a draw on the LOC upon an Event of Default. Notice of non-renewal, also according to the plain language of the agreement, constitutes an Event of Default, and the terms of the LOC provide that
Upon your receiving such notice of the nonrenewal of the expiration of this Letter of Credit, you may also draw under the Letter of Credit by presentation to us at our above address, on or before the expiration date specified in such notice, of your draft drawn on us at sight accompanied by your signed and dated statement in the form of Annex A attached hereto with the instructions in brackets therein complied with.
Ap. 58 (emphasis added.) Nothing in the LOC requires notice and an opportunity to cure. The LOC Addendum provides, "Upon the occurrence of an `Event of Default', Lessor [GECC] may draw all amounts available under the LOC but in no event more than an amount equal to the Lessor's Loss." GECC App. at 7. As the bankruptcy court recognized during oral argument, the LOC Addendum provides two remedies for the failure to maintain an evergreen letter of credit. Specifically, that failure entitles Lessor both to "exercise remedies pursuant to Section 15" and "draw all amounts available under the LOC" up to the Lessor's loss, which is defined separately. GECC App. at 7.
The Court is not persuaded that the lease agreement's definition of "Event of Default" required GECC to provide notice and an opportunity to cure in these circumstances. In particular, although the lease agreement does discuss both notice and an opportunity to cure, those provisions apply only to certain types of default, and do not apply to the failure to maintain an evergreen LOC. Although Tricord could have negotiated the LOC, Lease, and LOC Addendum differently, it did not do so. It is not the Court's task to rewrite the contract in terms more favorable to the debtor. Thus, if Tricord defaulted, GECC was entitled to draw on the LOC without providing notice or an opportunity to cure. GECC's draw was proper because the uncontested facts set out at trial established that Tricord defaulted.
It also appears that Tricord admitted, pursuant to Federal Rule of Bankruptcy Procedure 7036, that the failure to maintain an automatically renewable letter of credit constituted an event of default. Because the Court finds that GECC did not breach the lease as a matter of law, the Court need not discuss the admissions.
Because the Court is persuaded that the draw was authorized by the terms of the lease, the amount of the "Lessor's Loss" must be assessed. Although GECC argues that there is no need to remand to the bankruptcy court to make this determination, the Court disagrees. As with the amount of damages incurred in the subrogation, the initial determination of the "Lessor's Loss" is best determined in the first instance by the bankruptcy court. Therefore, the Court remands this issue for further proceedings not inconsistent with this opinion. Similarly, because this Court has found that no breach of contract has been established, there is no need for the Court to determine what rights, if any, Tricord reserved under the lease. However, if the bankruptcy court determines, pursuant to the terms of the Lease, that GECC drew more on the LOC than it was entitled to draw, the bankruptcy court will then have to determine whether, in light of the assignment to Adaptec, Tricord can pursue a claim for breach of contract.
ORDER
Based on the foregoing, all the records, files, and proceedings herein, the Court AFFIRMS IN PART AND REVERSES IN PART the Judgment of the bankruptcy court as follows:1. The bankruptcy court's order dated January 23, 2004 granting judgment in favor of plaintiff and against General Electric is REVERSED;
2. The bankruptcy court's order dated January 23, 2004 in favor of plaintiff and against defendant Adaptec is AFFIRMED on the alternate ground specified in the opinion;
3. The case is REMANDED to the bankruptcy court for further proceedings not inconsistent with this opinion