Third Circuit Court of Appeals Rules on Purchaser's Rights Under Rejected Real Estate Contract

In a non-precedential opinion, the Third Circuit Court of Appeals recently ruled on multiple issues arising from a Chapter 11 debtor's rejection of an integrated agreement for the lease and subsequent sale of real property. In re Nickels Midway Pier, LLC (Wild Waves, LLC v. Nickels Midway Pier, LLC), 2007 WL 4171114 (3d Cir. 2007). Specifically, the court looked to state law to determine that the agreement at issue was divisible into independent lease and sale components and that, upon rejection of the sale provision, the buyer held a bankruptcy claim rather than an equitable right to specific performance because state law provided an alternative remedy in the form of compensatory or "benefit of the bargain" damages. The court also held that because the non-debtor had not made any payments under the purchase agreement, it was not entitled to the protections afforded a purchaser of real estate under section 365(i) of the Bankruptcy Code. 

Wild Waves, LLC and Nickels Midway Pier, LLC were parties to an agreement by which Wild Waves agreed to lease a portion of an entertainment pier in New Jersey from Nickels for a three-year period and thereafter purchase it pursuant to an agreement that was never executed. In 2001, Nickels sued Wild Waves in New Jersey Superior Court, alleging that Wild Waves failed to perform its obligations under the lease. Wild Waves countersued for breach of the sale contract and sought specific performance. Nickels subsequently filed a voluntary chapter 11 petition and moved to reject the lease under 11 U.S.C. § 365(a). Wild Waves objected to the motion on several bases, arguing primarily that (i) the sale agreement was repudiated by Nickels pre-petition and was therefore not executory, (ii) Wild Waves was entitled to purchaser in possession protection under section 365(i) of the Bankruptcy Code and (iii) rejection would improperly extinguish Wild Waves' state law right to specific performance because monetary damages would not adequately compensate Wild Waves.

Before resolving the motion to reject, the Bankruptcy Court granted relief from the automatic stay to allow the New Jersey Superior Court to determine whether an enforceable  contract for the sale of the pier existed. The Superior Court held that a sale agreement did exist and that the lease and sale were two aspects of a thoroughly integrated agreement. In light of the Superior Court's conclusion, the Bankruptcy Court construed Nickels' motion to reject as seeking to reject a single, comprehensive agreement. Finding that the agreement was executory, that the rejection was an exercise of reasonable business judgment and that Wild Waves asserted a claim that could be discharged in bankruptcy, the Bankruptcy Court approved the rejection of the agreement. The Bankruptcy Court further concluded that Wild Waves was entitled to the benefit of the Bankruptcy Code's purchaser in possession protections thereby allowing Wild Waves to remain in possession of the pier provided that it continued to make all payments coming due under the sale contract and otherwise complied with section 365(i). 

Wild Waves and Nickels cross-appealed to the District Court. The District Court concluded that the Bankruptcy Court should have construed the agreement to lease and to sell the pier either as comprising two independent agreements or, in the alternative, as two divisible portions of an integrated agreement. The District Court determined that, in either event, the sale provision was executory and that Wild Waves was not entitled to the benefits of section 365(i). Finally, the District Court affirmed the Bankruptcy Court's determination that Wild Waves' claim for specific performance was a claim that could be discharged in a bankruptcy proceeding. The District Court remanded the case back to the Bankruptcy Court with instructions to consider independently the attempts to reject the lease and sale provisions and Wild Waves appealed to the Third Circuit.

In determining whether the agreement was divisible, the Third Circuit looked to state law and concluded that New Jersey law provides that a contract is divisible when performance is divided in two or more parts with a definite apportionment of the total consideration to each part. Noting that the lease and sale provisions were not contingent upon performance of the other, and that lease payments were not credited toward the sale price, the Third Circuit affirmed the District Court's conclusion that the Bankruptcy Court should have treated the sale provision as divisible from the lease provision. 

In analyzing Wild Waves' purchaser in possession rights, the court focused on section 365(i)(2)(A)'s requirement that a purchaser "shall continue to make all payments due." Because Wild Waves had not made payments toward the purchase of the pier, the court held that Wild Waves was not in a position to continue making such payments and therefore was not entitled to the protections provided by section 365(i). 

The Third Circuit also looked to New Jersey state law in determining whether Wild Waves' action for specific performance would constitute a dischargeable bankruptcy claim. Section 101(5)(B)'s definition of a claim includes the "right to an equitable remedy for breach of performance if such breach gives rise to a right to a payment." Under the specific facts before the court, New Jersey law presented an alternative to equitable relief  in the form of compensatory or "benefit of the bargain" damages. Accordingly, the Third Circuit Court held that Wild Waves asserted a claim within the meaning of section 101(5)(B) and was not entitled to specific performance. 

The Nickels case highlights the importance that state law plays in the determination of a party's rights under a rejected executory contract and exposes traps to be avoided in structuring a purchase of real property from a party that may be on uncertain financial ground. Under the line of reasoning employed in the Nickels case, a party seeking to take possession of property for the purposes of enjoying the purchaser in possession protections of 365(i) would be well-served to structure the transaction to include an early payment so that the purchaser is in a position to "continue to make all payments due" pursuant to section 365(i)(2)(A).