In re Republic Airways Holdings Inc.

598 B.R. 118

IN RE: REPUBLIC AIRWAYS HOLDINGS INC., et al., Debtors.

Case No. 16-10429 (SHL) (Jointly Administered)

United States Bankruptcy Court, S.D. New York.

Signed February 14, 2019

ZIRINSKY LAW PARTNERS PLLC, Counsel for Reorganized Debtors, 375 Park Avenue, Suite 2607, New York, NY 10152, By: Bruce R. Zirinsky, Esq., Sharon J. Richardson, Esq., Gary D. Ticoll, Esq.

HUGHES HUBBARD & REED LLP, Counsel for Reorganized Debtors, One Battery Park Plaza, New York, NY 10004, By: Christopher K. Kiplok, Esq., Gregory C. Farrell, Esq., Erin E. Diers, Esq.

VEDDER PRICE P.C., Counsel for Wells Fargo Bank Northwest, N.A., as Owner Trustee, and ALF VI, Inc., 1633 Broadway, 31^st Floor, New York, NY 10019, By: Michael J. Edelman, Esq., Arlene Gelman, Esq.

MEMORANDUM OF DECISION

SEAN H. LANE UNITED STATES BANKRUPTCY JUDGE

Before the Court is Republic Airways Holdings Inc., et. al. 's ("Republic" or the "Debtors") Motion for Summary Judgment with Respect to its Objection to Claims Filed by Wells Fargo Bank Northwest, N.A., as Owner Trustee, and ALF VI, Inc., as Owner Participant (the "SJM") [ECF No. 2029]. The SJM addresses two major issues in the aircraft leases between these parties: (i) whether the liquidated damages provisions in the leases violate Article 2A of the New York Uniform Commercial Code and are therefore unenforceable as against public policy, and (ii) if so, whether the guarantor of the obligations in the leases is nevertheless liable to pay the otherwise unenforceable liquidated damages. The SJM also encompasses a secondary issue of whether the lessor has a valid administrative priority claim for post-petition rent relating to certain aircraft. For the reasons set forth below, the Court grants the SJM, finding that the liquidated damages provisions in these leases are unenforceable because they violate Article 2A's requirement that they be reasonable in light of the then anticipated harm from default. In addition, the Court concludes that the liquidated damages provisions also cannot be enforced as against the guarantor and that the administrative expense claim is barred under the express terms of the stipulation between the parties.

BACKGROUND

This dispute centers around Amended Leases and corresponding Guarantees—both defined below—that are the operative agreements between the parties. But there are other agreements—also discussed below—that relate to the Amended Leases and contain provisions that are relevant to the issues before the Court today.

A. The Amended Leases and Related Agreements

Between June 2001 and November 2003, Wells Fargo Bank Northwest, N.A. ("Wells Fargo" or the "Lessor"), as owner trustee, on behalf of Mitsui & Co. (U.S.A.), Inc. ("Mitsui"), as the trust beneficiary, purchased seven EMB-145LR aircraft and entered into seven lease transactions (the "Original Leases")¹ with Chautauqua Airlines, Inc. ("Chautauqua" or the "Lessee"). Under the Original Leases, the aircraft bearing U.S. registration marks (or tail numbers) N286SK, N561RP, N562RP, N287SK, N288SK, N563RP, and N259JQ (each individually an "Aircraft" and collectively, the "Aircraft") were each leased to Chautauqua. See Response to Republic Undisputed Facts ... and Counter Statement by Residco Parties ("Residco Facts") [ECF No. 2049]. Under the terms of each Original Lease, Chautauqua agreed to pay monthly rent for each Aircraft during the term of the Original Lease as set forth on a schedule attached to that Original Lease. See Blank Decl., Ex. A (N286SK) § 4.01. Upon expiration of each Original Lease, Chautauqua was required to return the Aircraft to Wells Fargo. See id. , Ex. A (N286SK) § 18.01.

Around this same time, in connection with the Original Leases, Embraer S.A. ("Embraer"), the manufacturer of the Aircraft, and Mitsui entered into a deficiency agreement (the "Deficiency Agreements") and a Residual Value Guarantee Agreement (the "RVGs") for each Aircraft. Together, these agreements provided Mitsui protection from a decline in the estimated "residual value" of each Aircraft, i.e. the estimated value of the Aircraft at the end of the applicable Original Lease term. See Declaration of Gregory C. Farrell in Support of Republic's Motion for Summary Judgment ... (the "Farrell Decl."), Exs. H, O (N286SK), Exs. I, P (N287SK), Exs. J, Q (N288SK), Exs. K, R (N561RP), Exs. L, S (N562RP), Exs. M, T (N563RP), Exs. N, U (N259JQ); Residco Facts ¶¶ 4, 12, 16, 20, 24, 29, 35, 36; see also June 28, 2018 Hr'g Tr. [ECF No. 2075] at 36:23–25 (defining "residual value" as the "aircraft['s] worth at the end of the lease term"). More specifically, the RVGs provided that Embraer would pay Mitsui the difference between the previous month's so-called stipulated loss value and the Aircraft's fair market value up to a Maximum Amount (as defined in the RVGs) upon the expiration of the basic term of each Original Lease; the stipulated loss value was established on schedules affixed to each Original Lease, as described in greater detail below. See Residco Facts ¶ 35 (citing Farrell Decl., Exs. O, P, Q, R, S, T, U.).² Notably, Chautauqua never had any obligation to make any payments due to a decline in the residual value of the Aircraft upon expiration of the Original Leases. See generally Blank Decl., Ex. A (N286SK) Art. IV (Rent), Art. XVIII (Return of the Aircraft).

In late 2012, Mitsui and Chautauqua agreed to restructure the Original Leases. Accordingly, they entered into (i) amendments to the Original Leases (the "2012 Amendments"), (ii) a financial support agreement (the "Financial Support Agreement"), pursuant to which Mitsui agreed to provide Chautauqua with certain financial support payments,³ and (iii) a guarantee (the "Original Guarantee"), pursuant to which Republic Airways Holdings Inc. ("RAH"), one of the Debtors, guaranteed Chautauqua's obligations under the Original Leases. See Blank Decl., Exs. H–N (the 2012 Amendments), Ex. O (the Financial Support Agreement), Ex. P (the Original Guarantee). The 2012 Amendments provided for, among other things, altered return conditions. See, e.g. , id. , Ex. H (N286SK 2012 Amendment) Schedule A §§ 2, 5, 6. Roughly contemporaneously with the 2012 Amendments and Financial Support Agreement, Mitsui and Embraer entered into a Reimbursement Agreement (the "Reimbursement Agreement") under which Embraer agreed to make certain payments to Mitsui with respect to each Aircraft. See Amendment No. 1 to Original Guarantee, dated December 12, 2014 (the "Guarantee Amendment"), annexed to the Blank Decl. as Exhibit Q Schedule 2 § 2 (discussing Reimbursement Agreement).

In December 2013, Wells Fargo and Chautauqua entered into amended and restated leases for each Aircraft that superseded the Original Leases (the "Amended Leases"). See Blank Decl., Exs. R–X. The Amended Leases eliminated the reimbursement structure implemented through the Financial Support Agreement but preserved the adjustments to the Basic Rent. See, e.g. , id. , Ex. R (N286SK) § 4.01, Schedule BR; Residco Facts ¶ 42.

In December 2014, ALF VI, Inc. ("ALF," and together with Wells Fargo, "Residco") acquired the owner participation interests held by Mitsui for each of the Amended Leases. See Residco Facts ¶ 45. In connection with Mitsui's sale of its owner participant interests, Mitsui, Chautauqua, and Embraer agreed to terminate the Financial Support Agreement, the Reimbursement Agreement, and the Deficiency Agreements. See Guarantee Amendment Schedule 2 § 2.

B. Liquidated Damages and Stipulated Loss Values in the Amended Leases

The parties agree that each of the Amended Leases is identical as to the relevant provisions. See Residco Facts ¶ 30; see also June 28, 2018 Hr'g Tr. at 49:4–5 ("The parties agree that the same model was used for all these—all seven aircrafts."). Specifically, there is a contractual damages provision in each of the Amended Leases providing that, should the Lessee default, the Lessor may provide the Lessee with fifteen days' written notice and demand that the Lessee pay (i) any unpaid Basic Rent for the Aircraft, plus (ii) liquidated damages "for loss of bargain and not as a penalty (in lieu of Basic Rent payable for the period commencing after the date specified for payment in such notice)[.]" Residco Facts ¶ 30 (citing Blank Decl., Ex. A § 17.02(c), Ex. B § 17.02(c), Ex. C § 17.02(c), Ex. D § 17.02(c), Ex. E § 17.02(c), Ex. F § 17.02(c), Ex. G § 17.02(c) ).⁴ The Lessee then has the choice of liquidated damages as measured in three different ways, which make reference to various calculations of rent and stipulated loss value:

(i) stipulated loss value minus present value of the fair market rental value for the remainder of the Amended Lease term;

(ii) stipulated loss value minus the fair market sales value of the Aircraft; or

(iii) difference between present value of rent reserved for the remainder of the Amended Lease term and the fair market rental value for the remainder of the term.⁵

Reorganized Debtors' Objection to (I) Rejection Damage Claims, (II) Guarantee Claims and (III) Administrative Claim ... (the "Claims Objection") [ECF No. 1852] ¶ 36; see also Residco Facts ¶ 30 (citing Blank Decl., Ex. A § 17.02(c), Ex. B § 17.02(c), Ex. C § 17.02(c), Ex. D § 17.02(c), Ex. E § 17.02(c), Ex. F § 17.02(c), Ex. G § 17.02(c) ).⁶

Appended to each Amended Lease is a schedule (each, a "Schedule SLV") setting forth stipulated loss values ("SLVs") of the Aircraft for each month of the basic term. See Residco Facts ¶ 31. In each Schedule SLV, the SLV for the first month is equal to the purchase costs (price plus transaction expenses) of the Aircraft. See id. ¶ 32 (citing Expert Report of Howard K. Weber dated January 8, 2018 (the "Weber Report") at 5, attached to the Farrell Decl. as Ex. W ("[A]t the start of the Lease, the SLV liquidated damage amount is based upon and corresponds to a lessor's Invested Amount for a purchase aircraft[.]"); Transcript of Deposition of Ryoichi Matsuno (the "Matsuno Dep. Tr.") at 66:9–17, attached to the...