In re Hertz

Citations: 536 B.R. 434; 74 Collier Bankr. Cas. 2d 568; 2015 Bankr. LEXIS 3040; 61 Bankr. Ct. Dec. (CRR) 143; 2015 WL 5271332Docket: Case No.: 2:15-bk-12813-DS

Court: United States Bankruptcy Court, C.D. California; September 8, 2015; Us Bankruptcy; United States Bankruptcy Court

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Debtors John Edward Hertz and Diane Gam-roth Hertz filed a Motion to reject an executory contract with The Grayfox Trust regarding the sale of a property located at 28754 Grayfox Street, Malibu, California. The Debtors initially listed the property for $7,850,000 in January 2014, having previously evaluated its market value at approximately $8,500,000 in 2008 and between $8,000,000 and $8,500,000 in 2012. The Trust made an offer on June 26, 2014, which culminated in a counteroffer acceptance on July 3, 2014, with a sale price of $6,850,000 and a leaseback agreement for one year with an optional second year. Escrow was opened on July 9, 2014, and by August 2014, the Trust removed contingencies and amended the sale price to $6,840,000, with closing expected by August 29, 2014. However, the Debtors instructed the escrow holder not to close the sale due to unresolved liens against the property, which prompted the filing of the Motion to reject the contract. The background details include the involvement of escrow officer Stephany Keith and the issuance of several escrow instructions, alongside the discovery of monetary encumbrances and a lis pendens affecting the property.

Harfouche stated that Morse kept her informed about the Debtors’ negotiations with lienholders and suggested that the sale would close soon. Despite Debtors' requests, the Trust wired the sale funds into escrow on September 30, 2014. Harfouche and Morse discussed a potential extension fee of $3,000 per day for delays in closing escrow, which Hertz also acknowledged, although Morse and Hertz later characterized the fee as a demand from the Trust. An amended escrow instruction was prepared but not executed by the Debtors. On October 8, 2014, the Trust demanded the Debtors close escrow within three days, leading to the Trust filing a complaint in California Superior Court for specific performance on October 29, 2014, after the Debtors failed to comply. The Debtors filed for Chapter 11 bankruptcy on February 25, 2015, just as their opposition to the motion to compel arbitration was due. Subsequently, the Trust sought relief from the bankruptcy stay to continue its state court action, which was delayed pending the Debtors' right to reject the Purchase Contract. On May 14, 2015, the Debtors filed to reject the Purchase Contract, claiming it was executory and outlining nine points to support their position, including the lack of an executed closing statement, unresolved authorization for fund transfer, unwaived conditions for clean title, questions regarding the validity of the grant deed, potential fraud, inadequate property marketing, a competing broker's listing, undisclosed beneficiary identity, and the possibility of contract termination due to the escrow extension fee.

Debtors request the court to recognize a significant increase in the Los Angeles real estate market over the past year, arguing that rejecting the Purchase Contract will enable them to re-market the Property and potentially sell it for around $8,000,000, which they need for purchasing a new home and funding their retirement due to their advanced age. Opposing the Motion are the Trust, Coldwell, OneWest Bank, N.A., and creditor Edward A. Hoffman. The Trust contends that it has fulfilled its obligations, asserting that the Purchase Contract is not executory and that rejecting it would harm the Trust disproportionately, while not benefiting the estate or unsecured creditors. They argue that any potential increase in sale proceeds would be offset by claims for rejection damages, broker commissions, increased mortgage interest, capital gains tax, and litigation costs. The Trust also questions the good faith of the Debtors' bankruptcy filing. Coldwell emphasizes the arm’s length negotiations that resulted in the Purchase Contract, while OneWest points out that the estate is solvent and that speculation about a higher sale price would harm creditors and benefit only the Debtors. Hoffman reiterates the Trust’s concerns and highlights the lack of evidence supporting the Debtors' claim of achieving a fair market price. In their reply, the Debtors counter that the Trust is bound by its assertion of the Purchase Contract's fairness, thereby limiting its claim for damages. They also argue that Coldwell and Cortazzo cannot claim damages due to an expired listing agreement and mention ongoing litigation against them. The Debtors present a broker’s declaration valuing the Property at $7,800,000 to $8,000,000, along with comparative documents. They reference a nearby inferior property listed for $8,000,000, but the Trust counters with proof that it sold for $6,600,000 instead.

Debtors assert that the $6,600,000 price of an adjacent property reinforces their valuation of their own Property due to its superior condition and landscaping. The discussion focuses on whether the Purchase Contract qualifies as an executory contract under the Ninth Circuit's "Countryman" definition for section 365 purposes. According to this definition, a contract is executory if the obligations of both parties are so underperformed that a failure by either would constitute a material breach excusing the performance of the other. Debtors invoke the Ninth Circuit's ruling in *Alexander*, which addressed the rejection of a real estate purchase contract. In that case, the buyer made an initial deposit and later provided additional funds but had not fully paid the purchase price. The court determined that the contract remained executory because the buyer had only tendered performance, not fully performed, leaving the question of executory status unclear, particularly regarding the distinction between performance and tender of performance. Subsequent interpretations, such as in *Aslan*, suggest that a purchase contract remains executory if escrow has not closed, further complicating the understanding of the *Alexander* ruling. Other cases echo this ambiguity, indicating that the *Alexander* decision does not clarify whether the executory nature hinges on the buyer's loan status or the closure of escrow.

In the case In re 72 Townsend, LLC, the court examined the nature of a real estate sale contract in relation to the performance obligations of the buyer. The ruling cited Alexander, which classified a real estate sale contract as executory due to the buyer's incomplete payment. However, the court distinguished this case from Alexander, emphasizing that the buyer in the current matter had already fulfilled their obligations by depositing the full purchase price into escrow and removing all contingencies under the Purchase Contract. The court referenced a prior decision, Zeiler v. Matt, where the court found that deposits made by bidders represented full performance rather than mere tender of performance. The Matt court's interpretation was preferred, as it viewed the facts as sufficiently distinct from those in Alexander, which hinged on the buyer's outstanding payment obligations. The court acknowledged that the Trust had deposited the full purchase price and highlighted that the August 12, 2015, Amended Escrow Instructions indicated that escrow would close without further instruction once the Trust completed the wire transfer. The Debtors' argument that the Trust had not authorized escrow to transfer funds was countered by the clear instructions stating otherwise.

The Debtors' Motion fails to show that the Trust has not fulfilled its obligations under the Purchase Contract, with only one item questioning the Trust's performance based on a claim regarding the waiver of clear title. This argument is deemed absurd since there is no obligation for the Trust to provide such a waiver, and the Trust's lack of waiver cannot constitute a material breach that would render the Purchase Contract executory. Consequently, the Trust has fully performed, making the Purchase Contract non-executory.

Even if the Purchase Contract were considered executory, the rejection is argued to be against the best interests of creditors. Under 11 U.S.C. § 365(a), rejection requires court approval through a noticed motion, and decisions about rejection are subject to the business judgment test. The court presumes that the debtor acts prudently and in good faith, and should only disapprove if the decision is manifestly unreasonable or based on bad faith. The key consideration for the court is whether rejection would benefit general unsecured creditors, with a warning that rejection should not primarily benefit the debtors.

The Trust and other objectors contend that rejecting the Purchase Contract is not in the estate's or creditors' best interests for several reasons: the hypothetical $8,000,000 sale price is speculative and lacks evidence; any potential increase in sale proceeds would be offset by rejection damages, costs, and tax implications; and the sale under the existing contract would suffice to satisfy all creditors, suggesting the Debtors seek to secure additional funds for personal gain.

Finally, the Debtors' assertion that the Property is valued at $8,000,000 is not substantiated, as they provide conflicting claims about its worth, either at the time of listing or based on a supposed increase in value since accepting the Trust's offer of $6,850,000.

The Debtors claim a value of $8,000,000 for the Property, supported by several pieces of evidence: (1) a 2008 letter from Cortazzo estimating the market value at approximately $8,500,000; (2) a 2012 letter from Cortazzo suggesting a potential sale price between $8,000,000 and $8,500,000; (3) an unsigned listing agreement proposing a list price of $7,999,000; (4) a declaration from a new broker valuing the Property between $7,800,000 and $8,600,000; and (5) another declaration from the same broker affirming the Property's value despite an adjacent property selling for $6,600,000. However, the court finds the older letters from Cortazzo unhelpful in establishing current value, and the unsigned listing agreement does not substantiate the Debtors’ claims. 

The Debtors listed the Property for $7,850,000 in January 2014 without receiving offers for nearly six months, raising questions about their valuation claim. The argument that prior brokers were self-dealing does not explain the lack of interest in the Property. The court notes that the Debtors’ rejection of the Purchase Agreement seems speculative and not based on a prudent assessment of the Property's value, particularly as they have not provided an appraisal. The court may deny the rejection of the contract if the Debtors' decision appears erroneous or speculative.

Additionally, the Trust and objecting parties argue that even if the Property sells for $8,000,000, the increased proceeds would not benefit unsecured creditors due to potential rejection damages owed to the Trust, which would include the difference between the contract price and the Property's value at the time of the bankruptcy filing.

Debtors acknowledge that under California Civil Code § 3306, the Trust may claim certain expenses and interest, implying that any increased sale proceeds would be reduced by these amounts. If the Debtors reject the Purchase Contract, they may incur an additional $342,000 liability to brokers Coldwell and Cortazzo, regardless of whether the contract is honored or rejected. The Debtors contend that their listing agreement with Cortazzo expired on May 11, 2014, suggesting they owe no commission for a new sale. However, without evidence of an agreement extension or commission obligations, rejecting the Purchase Contract could result in losing a commission-free sale for one likely incurring broker fees.

Objecting parties highlight that rejecting the Purchase Contract could delay the sale, leading to accruing interest on the Debtors' mortgage and other creditor claims, which may increase administrative expenses related to finding a new broker and litigation. The unpredictability of these costs raises concerns about the Debtors' rationale for rejecting the contract, as they cannot ascertain when or at what price the Property may sell.

Additionally, the Trust warns that increased sale proceeds could be subject to capital gains tax up to 37.1%, a claim the Debtors dispute without providing counter-evidence, arguing instead that their tax basis is uncertain due to unfiled returns and suggesting potential limitations on capital gains tax after deducting sale costs and expenses.

The court cannot determine the impact of potential increased capital gains taxes due to uncertainties surrounding the Debtors' situation, which raises questions about the prudence of rejecting the Purchase Contract. The Debtors' rejection appears to primarily benefit themselves, as objectors, including the Trust, argue that proceeds from the Purchase Contract would likely satisfy all creditor claims in full. If the contract is rejected, unsecured creditors face uncertainty regarding the sale of the Property, while administrative expenses and interest on secured claims accumulate. The Debtors have not provided convincing arguments that a speculative future sale would yield better outcomes for unsecured creditors compared to the confirmed sale to the Trust for $6,850,000. The court emphasizes the risk of jeopardizing creditors’ recoveries for the Debtors’ potential personal gain, particularly as the Debtors approach retirement.

Additionally, the court notes procedural issues with the grant deed related to the signatures of John and Diane Hertz, with discrepancies in the notary block. The court critiques the Debtors' interpretation of relevant case law, stating it conflicts with California law regarding specific performance in real estate transactions. The Debtors’ argument that a neighboring property's sale price supports their valuation of the Property is dismissed, as evidence shows that the neighboring property sold for $6,600,000, not $8,000,000 as claimed. Consequently, the court denies the Debtors' motion and will issue a separate order reflecting this decision.