Unpublished Disposition, 902 F.2d 39 (9th Cir. 1986)

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US Court of Appeals for the Ninth Circuit - 902 F.2d 39 (9th Cir. 1986)

HOTEL MANAGEMENT AND ASSOCIATES, INC.; M.N. Sandler andAssociates, Inc., Plaintiffs-Appellants,v.HANSEN, HANSEN & JOHNSON; G & B Investment Company, Inc.,Defendants-Appellees.

No. 89-35367.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 8, 1990.Decided May 11, 1990.

Before FARRIS, PREGERSON and BOOCHEVER, Circuit Judges.


Appellants Hotel Management Associates (HMA) and M.N. Sandler and Associates (MSA) appeal from a district court order affirming the bankruptcy court orders disallowing their respective claims against debtor Tacoma Dome Hotel (TDH). Appellants contend that the bankruptcy court erred in disallowing their claims under 11 U.S.C. § 502(b) (1) because appellees Hansen, Hansen & Johnson (HHA) and G & B Investment Co., Inc. (GBI), as proponents of TDH's Plan of Reorganization, attempted to reject only those parts of TDH's executory contracts with appellants that are disfavorable to TDH while attempting to assume the favorable portions of those contracts. Appellants also contend that they are entitled to payment of appellants' claims under the Plan of Reorganization because appellees converted their executory contract claims into claims as unsecured creditors by rejecting the contract claims. We reject appellants' contentions and affirm the district court's order.


TDH, a limited partnership, was formed in 1983 to construct and operate the Tacoma Dome Hotel. Disclosure Statement Information Concerning Debtor and Proposed Plan of Reorganization (Disclosure) at 1. The partnership consisted of three general partners, appellee HHJ, appellee GBI, and Martin N. Sandler, as well as 72 limited partners. Id. Sandler owned the largest of the general partnership interests and was named Managing General Partner, although HHJ and GBI together held a majority interest in TDH. Id. Appellants MSA and HMA were listed as affiliates of Sandler in sections 5.2(A) (i) and (iv) of the partnership agreement. Appellee's Excerpts of Record, Exhibit E, at 15.

Prior to the limited partnership's formation, the general partners entered into two separate contracts with appellants. Id. Under the MSA contract, MSA was to develop the hotel. Id. Eight hundred thousand dollars ($800,000) of MSA's fee was to be deferred until the hotel generated "sufficient net spendable income."1  Developer's Agreement Between TDH and MSA at Sec. 7.01. Under the HMA contract, HMA was to manage and operate the hotel. Appellees' Excerpts of Record, Exhibit E, at 15. HMA was to be paid on a monthly basis a fee equal to five percent of the hotel's gross revenues. Id. This fee, which amounted to approximately $200,000, was to be subordinated to the debt service if the hotel failed to generate enough income to pay its debt service. Id. These contracts were ratified and assumed by TDH under the terms of the partnership agreement. Id. The deferred fees under both contracts were subordinated to the payment of the limited partners' preferred return under the partnership agreement. Brief for Appellees (Red Brief) at 9.

The hotel opened on August 17, 1984, and immediately began to lose money. Disclosure at 2. The general partners disagreed on how the hotel should be operated. Id. On February 14, 1985, HHJ and GBI removed Sandler from his position as Managing General Partner, replacing him with HHJ. Id. The limited partnership agreement, however, remained in effect. Red Brief at 9. On July 22, 1985, TDH petitioned for involuntary reorganization under Chapter 11 of the Bankruptcy Code after nearly eleven months of continuous losses. Disclosure at 2.

Appellees filed a Plan of Reorganization for TDH on August 8, 1986. Under this plan, all of TDH's executory contracts, including those with appellants, were classified as Class 16 claims. Plan of Reorganization at 8, p 3.16. All of TDH's executory contracts were rejected except for those with Group W Cable and Sound Elevator. Id. at 26, p 8.1. The plan further provided that all claims arising from rejected executory contracts were to be considered as Class 17 claims. Class 17 claims were " [a]ll unsecured claims exclusive of Classes 2 (expenses of administration), 4 (tax liabilities), 16, and 19 (General Partners' claims and interests)." The limited partnership agreement, however, was not rejected under the Plan. Red Brief at 9. This plan was confirmed by the bankruptcy court on September 24, 1986.

Appellants subsequently filed objections to the rejection of their respective claims. The bankruptcy court found that their respective rights to demand payment under the MSA and HMA contracts depended on the occurrence of two conditions precedent. For MSA, the condition precedent was that TDH had to generate net spendable income; for HMA, the condition precedent was that TDH had to have sufficient income to pay its debt service. The bankruptcy court found that neither condition precedent was satisfied, and that, therefore, the claims based on these contracts were unenforceable under 11 U.S.C. § 502(b) (1). The bankruptcy court disallowed both objections. The district court affirmed both bankruptcy court orders in a single order.


We have jurisdiction over this appeal pursuant to 28 U.S.C. § 1291. The district court had jurisdiction over this appeal pursuant to 28 U.S.C. § 158(a).


We review the bankruptcy court's findings of fact by the clearly erroneous standard of Fed. R. Civ. P. 52(a). In re American Mariner Indus., Inc., 734 F.2d 426, 429 (9th Cir. 1984). We review de novo the bankruptcy court's conclusions of law. Id. We review the district court's interpretation of state law de novo. Matter of McLinn, 739 F.2d 1395, 1397 (9th Cir. 1984) (en banc). Since we are applying Washington law, we are bound by the decisions of the Washington Supreme Court, and must look first to that court's case law. Olympic Sports Prod. v. Universal Athletic Sales, 760 F.2d 910, 912-13 (9th Cir. 1985), cert. denied sub nom Whittaker Corp. v. Olympic Sports Prod., Inc., 474 U.S. 1060 (1986).


Appellants contend that the bankruptcy court erred in disallowing their claims because, by asserting the non-occurrence of the relevant conditions precedent, appellees sought to assume the beneficial portions and reject the negative portions of the executory contracts. Appellants' contention is without merit.

Under 11 U.S.C. § 502(b) (1), a bankruptcy court shall allow a claim unless "such claim is unenforceable against the debtor, and unenforceable against the property of the debtor, under any agreement or applicable law." "When a bankruptcy court adjudicates a contract claim in connection with a petition in bankruptcy, the court applies state law to the contract dispute unless the bankruptcy code provides otherwise." Matter of Sparkman, 703 F.2d 1097, 1099 (9th Cir. 1983). Appellants' rights to receive payment under the respective contracts must be enforceable under Washington law in order for their claims to be allowable under 11 U.S.C. § 502(b).

Under Washington law, the " [n]onperformance or nonoccurrence of a 'condition' prevents the promissee from acquiring a right, or deprives him of one, but subjects him to no liability." Ross v. Harding, 391 P.2d 526, 530 (Wash.1964) (citations omitted). Washington defines a condition precedent as "those facts and events, occurring subsequently to the making of a valid contract, that must exist or occur before there is a right to immediate performance, before there is a breach of contract duty, before the usual judicial remedies are available." Id. Washington determines if a contract provision is a condition precedent by examining "the intent of the parties, to be ascertained from a fair and reasonable construction of the language used in the light of all surrounding circumstances." Id. at 531 (citation omitted).

The bankruptcy court found that both appellants' respective rights to payment depended on the occurrence of conditions precedent that never occurred. MSA's right to receive its $800,000 deferred fee depended on TDH generating net spendable income. HMA's right to receive its $200,000 depended on TDH generating sufficient income to pay its debt service. The bankruptcy court found that TDH never generated net spendable income and never generated sufficient income to pay its debt service. Because these conditions never occurred, the bankruptcy court held that appellants did not acquire a right to receive their respective payments, and consequently disallowed their claims under 11 U.S.C. § 502(b) (1).

Under 11 U.S.C. § 365, which allows debtors to assume or reject executory contracts, debtors may not assume only the beneficial portions of an executory contract and reject only the detrimental portions of an executory contract. See In re Pacific Exp., Inc., 780 F.2d 1482, 1488 (9th Cir. 1986). Appellants contend that here appellees seek enforcement of only certain provisions of the contracts--the conditions precedent. Appellees, however, do not attempt to assume the beneficial portions of these rejected contracts by asserting the non-occurrence of the conditions precedent as grounds for disallowing these claims. Rather, they simply argue an interpretation of the entire contracts.

Appellants argument misinterpret case law on this point. Cases in which a debtor has been found to have assumed only the beneficial parts of an executory contract involve attempts to continue exercising a beneficial provision of a contract, such as a leasehold, while rejecting the remainder of the contract. See, e.g., In re Holland Enterprises, Inc., 25 B.R. 301, 303 (E.D.N.C. 1982). The rule against a debtor's partial rejection of executory contracts has also been used to prevent a creditor from enforcing non-competition clauses of franchise contracts rejected by debtors. See, e.g., In re Rovine Corp., 6 B.R. 661, 666 (Bankr.W.D. Tenn. 1980) (cited with approval in In re Pacific Exp., Inc., 780 F.2d at 1488)). In the present case, the debtor seeks continued enforcement of no provisions of the MSA or HMA contracts. Those contracts are unenforceable as a matter of state law.

The bankruptcy court correctly disallowed appellants' claims under 11 U.S.C. § 502(b) (1).2 


The bankruptcy court was correct in disallowing appellants' claims because their rights to payment were unenforceable due to the non-occurrence of the respective conditions precedent. Appellants' are not entitled to payment as general unsecured creditors.

The judgment of the district court is AFFIRMED.


This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by 9th Cir.R. 36-3


The deferral of $800,000 of MSA's fee was required by the terms of a loan agreement between the limited partners and Westside Federal Savings and Loan. Net spendable income was defined by the loan agreement as:

all cash receipts received by Borrower from operations, including without limitation income received from concessionaires, and interest receipts, increased by Net Syndication Proceeds and reduced by (a) Operating Expenses, (b) Capital Expenditures, (c) Operating Reserve, (d) Debt Service Reserve, and (e) amounts paid against the Limited Partners' Preferred Return (as defined in the Limited Partnership Agreement). (Emphasis in Original.)


Even if the contracts are enforceable, appellants' contention that their rejected executory contract claims must be allowed as Class 17 claims by unsecured creditors is without merit. Those claims would still be subject to subordination to the preferred return of the limited partners under the terms of the limited partnership agreement. This agreement was not rejected by the limited partners. " [C]lassification of claims 'is simply a method of recognizing difference in rights of creditors which calls for differences in treatment." Matter of Sterling Homex Corp., 579 F.2d 206, 211 (9th Cir. 1978) (quoting Scherk v. Newton, 152 F.2d 747, 750 (10th Cir. 1945). The fact that a claim is classified in a certain way does not create a right to payment when the claim is subject to a valid subordination agreement. "A subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law." 11 U.S.C. § 510(a)

"Bankruptcy courts are empowered to subordinate claims where subordination will promote a just and equitable distribution of the bankrupt estate." In re Westgate California Corp., 642 F.2d 1174, 1177 (9th Cir. 1981). Subordination's fundamental purpose "is to undo or to offset any inequity in the claim position of a creditor that will produce injustice or unfairness to other creditors in terms of the bankruptcy results. Id. at 1177 (quoting In re Kansas City Journal-Post Co., 144 F.2d 791, 800 (8th Cir. 1944)). Appellants' contention that they are entitled to payment on their claims as general unsecured creditors under the terms of the Plan would actually cause injustice and an inequitable distribution of TDH's assets because it would put appellants in a better position than they would enjoy had bankruptcy not occurred.