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IN THE UNITED STATES BANKRUPTCY COURT
FOR THE WESTERN DISTRICT OF TEXAS
EL PASO DIVISION
IN RE:
EL PASO CHILDREN’S HOSPITAL
CORPORATION,
DEBTOR.
EIN: 26-3075429
4845 ALAMEDA AVENUE
EL PASO, TEXAS 79905
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CASE NO. 15-30784-HCM
CHAPTER 11
DEBTOR’S OBJECTION TO MOTION TO
COMPEL PAYMENT OF FACILITY LEASE
TO THE HONORABLE U.S. BANKRUPTCY JUDGE H. CHRISTOPHER MOTT:
COMES NOW El Paso Children’s Hospital Corporation (“EPCH” or “Debtor”), the
Debtor-In-Possession in this case, and files its Objection to the Motion to Compel Payment of
Facility Lease (“Motion”) filed by El Paso County Hospital District d/b/a University Medical
Center of El Paso (“UMC”), and in support thereof, respectfully show the Court as follows:
I. EXECUTIVE SUMMARY
1.
By its Motion, UMC impermissibly seeks to compel the payment of “Base Rent”
that the Debtor does not owe under that certain Lease Facility Agreement (“Lease”) between the
parties at issue in the UMC Adversary.1 The Court should deny the Motion.
2.
The Debtor is a non-profit children’s hospital that has no equity interests.
As such, the absolute priority rule of 11 U.S.C. §1129(b)(2)(B)(ii) does not apply. In re Wabash
Valley Power Ass'n, 72 F.3d 1305, 1319 (7th Cir. 1995) (citing In re Whittaker Memorial
Hospital Ass'n, 149 B.R. 812 (Bankr. E.D. Va. 1993)) (holding that the absolute priority rule
1
The UMC Adversary refers to Adv. Pro. No. 15-03005; El Paso Children’s Hospital Corporation v. El Paso
County Hospital District d/b/a University Medical Center of El Paso; pending in the United States Bankruptcy
Court for the Western District of Texas, El Paso Division.
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does not apply to a non-profit hospital board). Thus, the Debtor may confirm a plan that does
not pay all creditors in full. Id.
3.
Second, UMC is an insider of the Debtor. That conclusion is based, in part, on
the following, uncontroverted facts:
•
UMC’s CEO, Jim Valenti, acted as the Debtor’s first CEO2
and participated in the selection of the Debtor’s next CEO,
Larry Duncan.3
•
UMC chose the design of the Debtor’s children’s hospital
made subject to the Lease.4
•
UMC’s board members regularly attended the Debtor’s
board meetings and Mr. Valenti, and CFO, Michael Nunez
at all times had ex officio positions; and they attended the
Debtor’s board meetings including executive sessions
thereof.5
•
At least one UMC board member was a member of both the
UMC and the Debtor board.6
•
At all times, UMC has controlled the Debtor’s mail,
loading dock, payroll functions, information technology
systems, and infrastructure.7 At the Debtor’s inception,
UMC controlled all of the Debtor’s accounting, financial
reporting, billing, and payables.8 And, through its control
2
See Ex. A, Tr. 8/11 Hr’g 171:24-172:2. On August 11, 2015, the Court conducted a hearing on the Debtor’s
Motion for Entry of an Order Extending its Exclusivity Periods to File and Solicit a Plan of Reorganization [Dckt.
No. 165] and UMC’s (I) Objection to Debtor’s Motion for Extension of Exclusivity Periods and (II) Motion to
Terminate Exclusivity Periods Pursuant to 11 U.S.C. § 1121(D) [Dckt. No. 177]. A true and correct copy of the
transcript of the Exclusivity Hearing is attached hereto as Exhibit A. The transcript of the Exclusivity Hearing will
be cited as follows: Ex. A, Tr. 8/11 Hr’g ___:___.
3
See Ex. A, Tr. 8/11 Hr’g 172:16-25.
4
See Ex. A, Tr. 8/11 Hr’g 169:21-170:17.
5
See Ex. A, Tr. 8/11 Hr’g 172:3-15.
6
See Ex. A., Tr. 8/11 Hr’g 182:11-22.
7
See UMC Termination Motion, ¶¶ 4 & 53 (admitting that “UMC provides the Children’s Hospital with, among
other things, facilities, information technology, and biomedical equipment pursuant to leases and various
administrative services, including financial, accounting, communications, human resources, laundry, environmental
services, dietary, safety, and pharmaceutical services.”).
8
See UMC Termination Motion, ¶ 53 (admitting that “[t]he Debtor relies on UMC for nearly every vital service it
provides” and “UMC provides essentially all vital services . . ., including among others, accounting/bookkeeping,
security, information technology, imaging, laboratory services, nurse education, biomedical services, janitorial, and
parking services.”).
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of both hospitals’ information systems, UMC still has
unfettered access to all of the Debtor’s information.9
•
4.
None of the transactions between the Debtor and UMC are
ordinary, arms’ length transactions10 and they were
negotiated in an atmosphere of overlapping and revolving
door directorates, take-it-or-leave it ultimatums, and the
overarching theme of “trust us.”11
Given that UMC is an insider, and given the Debtor’s historical insolvency,
UMC’s lien is subject to perfunctory avoidance under 11 U.S.C. § 547(b)(4)(B). See Think3
Litigation Trust v. Zuccarello (In re Think3, Inc.), 529 B.R. 147 (Bankr. W.D. Tex. 2015).
5.
Because UMC is an insider, the Debtor’s debt to UMC, as a whole, meets many
of the factors necessary for recharcaterization as subordinate to general unsecured creditors. See
Grossman v. Lothian Oil, Inc. (In re Lothian Oil), 650 F.3d 539, 544 (5th Cir. 2011). Those
factors include:
(1) the intent of the parties; (2) the identity between creditors and shareholders;
(3) the extent of participation in management by the holder of the instrument;
(4) the ability of the corporation to obtain funds from outside sources; (5) the
'thinness' of the capital structure in relation to debt; (6) the risk involved; (7) the
formal indicia of the arrangement; (8) the relative position of the obligees as to
other creditors regarding the payment of interest and principal; (9) the voting
power of the holder of the instrument; (10) the provision of a fixed rate of
interest; (11) a contingency on the obligation to repay; (12) the source of the
interest payments; (13) the presence or absence of a fixed maturity date; (14) a
provision for redemption by the corporation; (15) a provision for redemption at
the option of the holder; and (16) the timing of the advance with reference to the
organization of the corporation.
9
See UMC Termination Motion, ¶ 53.
The Debtor’s original CEO was selected at the hand of UMC’s CEO, Mr. Valenti, as was the Debtor’s first
outside counsel. See Ex. B, Tr. 7/30 Hr’g 147:19-149:6; See Ex. B. Tr. 7/30, Hr’g 119:13-120:1. On July 30, 2015,
the Court conducted a hearing on the Debtor’s Emergency Motion Pursuant to 11 U.S.C. § 363 for (I) Authority to
Use Cash Collateral in the Ordinary Course; (II) Provide Adequate Protection; and (III) Scheduling Final Hearing
(“Cash Collateral Hearing”). A true and correct copy of the transcript of the Cash Collateral Hearing is attached
hereto as Exhibit A. The transcript of the Cash Collateral Hearing will be cited as follows: Ex. B, Tr. 7/30 Hr’g
___: ____.
11
See Ex. B, T. 7/30 Hr’g 136:14-17 (Mr. Legate testified that no written agreement stated that the Lease had to be
in place to facilitate an intergovernmental transfer, testifying that “it’s, ‘Just trust me.’ We can’t put it in writing.”).
10
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Fin Hay Realty Co. v. United States, 398 F.2d 694, 696 (3d Cir. 1968) (emphasis added); see
Lothian Oil, 650 F.3d at 544 (referring to Fin Hay Realty, 398 F.2d at 696, for a list of the
factors for recharacterization).
6.
Recharacterization may be proven at confirmation. In re Mangia Pizza Invs., LP,
480 B.R. 669, 706-8 (Bankr. W.D. Tex. 2012) (applying Lothian to confirm creditor’s plan based
on evidence at confirmation). In addition to the Lothian factors, UMC’s outsized claims suffer
from other infirmities that likewise demonstrate UMC’s motive to both profit from and control
the Debtor. The uncontroverted testimony shows that UMC’s expenditures on account of the
Debtor’s opening resulted in an increase of only $3.6 million per year even before accounting for
medical cost inflation.12 Analysis of UMC’s fiscal year 2014 audited financials show that UMC
as an organization lost $50.247 million, of which only $5.87 million can be attributed to EPCH
based on pro forma consolidation.13 These figures reinforce APS’s bottom-up analysis of the
true costs to UMC to provide services to the Debtor, including use of the premises, at $ 4.871
million.14
The Debtor’s current payments to UMC under the existing cash collateral order15
total an annualized $15,886,000 against a maximum estimated cost of $5 million or three times
UMC’s actual cost. As a result, UMC’s claim of over $100 million against actual costs or value
provided of less than $12 million defies credulity.
7.
Third, the uncontroverted evidence demonstrates that the Lease is not a “true
lease,” but instead a disguised financing transaction, i.e., a mechanism conjured up by UMC to
12
See Ex. C, Admitted at 8/11 Hr’g (Review of FY 12 versus F13 – UMC Audited Financial Statements and
Estimated Consolidating Income Statements for EPCH and UMC for FY 14).
13
See Ex. C, Admitted at 8/11 Hr’g (Review of FY 12 versus F13 – UMC Audited Financial Statements and
Estimated Consolidating Income Statements for EPCH and UMC for FY 14).
14
See Ex. D, Admitted at 8/11 Hr’g (Flow of Funds Power Point and Supporting Schedules). See Ex. A., Tr. 8/11
Hr’g 51:14-25-52:6 (Mark Herbers testified that UMC revenues over $820,000/month base costs from the Debtor).
15
See Agreed Fourth Interim Order (I) Authorizing Use of Cash Collateral, (II) Granting Adequate Protection; and
(III) Scheduling Final Hearing (“Fourth Interim Cash Collateral Order”) [Dckt. No. 209].
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facilitate the receipt of potential intergovernmental funding (“IGT”) or reimbursement. UMC
has consistently acknowledged that such funding is no longer available to the Debtor or is greatly
reduced, for various reasons.16
Most recently, UMC made the decision to cease its IGT
sponsorship of the Debtor because of the Debtor’s decision to seek protection under the
Bankruptcy Code.17
8.
The Debtor has presented testimony of several witnesses that categorically
demonstrate that UMC insisted upon the Debtor entering into an agreement denominated a
“lease,” while the Debtor and UMC were entering into agreements for services for the
functioning of the Debtor. The rent that UMC now claims is owed bears no relation to the
Debtor’s use of the Premises, because the costs of the Premises and certain information
technology equipment were fully funded by the taxpayers of El Paso. To the extent that any
consideration is due to UMC from the Debtor in conjunction with the Lease, the Debtor readily
provides ample consideration to UMC through the Debtor’s assumption of UMC’s obligation to
care for the indigent pediatric population for which UMC receives ad valorem tax revenue, and
payment of over-priced ancillary services. Thus, despite UMC’s merely superficial arguments to
the contrary, § 365(d) does not apply because rent payment under the Lease is not in
compensation of the Debtor’s use of the premises, and the Lease is not a “true lease.”
9.
Fourth, the law does not require the Debtor to perform any post-petition
nonresidential lease obligations until such lease is assumed or rejected when no such obligations
16
See Ex. D, p. 2 (Recital K) (“Whereas, significant changes in health care funding at the state and federal level
have impacted the projected revenue generation and cash flow available to EPCH in its start up phase and as a result
EPCH is presently unable to make payments to the District in full accordance within the terms of the Covered
Agreements, as more specifically described in Exhibit A- Covered Agreements and Exhibit B- Schedule of
Balances, attached hereto and incorporated herein by reference, and requires additional time to make payments”).
17
See Ex. F, Tr. 147:1-25-148:1-25 (Mr. DeGroat testified that UMC is no longer the IGT sponsor of the Debtor
since the Debtor’s bankruptcy filing).
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exist in the first place. See GE Capital Corp. v. Collins & Aikman Corp. (In re Collins &
Aikman Corporation), 351 B.R. 459 (E.D. Mi. 2006) (noting that entitlement to payments under
§ 365 depended upon whether the leases were “true leases.”). Consistent with the provisions of
the Lease and the parties’ other agreements, the Debtor has paid no Base Rent to UMC during
the pendency of this bankruptcy case because UMC was not, and is not, entitled to any such
payments. In the Motion, UMC offers an unreasonable interpretation of the Lease that fails to
address material provisions within its four-corners. See Motion, ¶¶ 22-35. Those material
provisions, together with admissible extrinsic evidence, establish that the Debtor is not obligated
to pay the Base Rent amounts UMC alleges are owed thereunder, and the Lease is not a “true
lease.”
10.
The Master Agreement wholly integrates the Lease and controls the Lease.18
Section 15.23(b) of the February 1, 2012 Master Agreement between UMC and the Debtor (the
“Master Agreement”), allows for an adjustment of the “Base Rent” upon the occurrence of a
force majeure event.19 The evidence shows that such a force majeure event has occurred.20
Moreover, UMC itself agreed that such a force majeure event occurred, as it recognized in the
February 1, 2013 Agreement On Obligations Between UMC and EPCH a/k/a the Forbearance
Agreement between the parties (the “Forbearance Agreement”).21
11.
The Debtor contends that such adjustment of the Base Rent occurred via a signed,
written “Document Acknowledgment” between the parties dated September 18, 2014 (“2014
Amendment”), by which the parties agreed that the Debtor would not pay any amounts for rent
18
See Ex. G, ¶¶ 4.1-4.7; 16.1-16.1.8; Ex. B, 7/30 Tr. Hr’g 106:7-14.
See Ex. G, ¶ 15.23(b).
20
See Ex. B, 7/30 Tr/ Hr’g 106:25-108:25 (Mr. Legate testified that the changes described in ¶ 15.23(b) occurred
because “cost-based reimbursement went away . . . very quickly after these agreements were done.”).
21
See Ex. E, p. 2 (Recital K).
19
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to UMC.22 And assuming arguendo that no such reformation took place (although it did), then
UMC has a contractual obligation under both § 13.6 of the Master Agreement and § 19.2 of the
Lease to agree to such an adjustment through good faith negotiations23 and it has refused to fulfil
that obligation. Instead, as established by the testimony of Mr. Valenti, UMC continues to take
the ludicrous and contradictory position that the Debtor never requested a rent adjustment,24
despite the fact that such negotiations did in fact include the issue of Base Rent, as evidenced by
the June 20, 2014 correspondence from the Debtor to UMC, in which the Debtor states that it
“hereby gives notice to UMC of its request to negotiate in good faith amendments to the
Agreements, including appropriate adjustments to the rent and fees set forth in such
Agreements” (emphasis added)).25
12.
Finally, the Court should deny the Motion as a matter of equity. See 11 U.S.C.
§ 105(a) (“The court may issue any order . . . that is necessary or appropriate to carry out the
provisions of this title.”); see F.D.I.C. v. Jones (In re Jones), 966 F.2d 169, 173 (5th Cir. 1992)
(discussing § 105(a) and the court’s “equitable power and duty to sift the circumstances
surrounding any claim to see that injustice or unfairness is not done in administration of the
bankruptcy estate.” (internal quotations omitted)). The issue of payments owed under the Lease,
and whether the Lease should be recharacterized will be tried in less than two months.26
13.
And the potential injury to UMC should the Court deny the Motion in the interim
period is only the potential of money it should be able to survive without for those two months
given its allegations of financial stability (e.g., the allegation under its proposed plan for
22
See Ex. H, p. 2 (identifying no Base Rent payable by the Debtor for years 2014 or 2015.
See Ex. G, ¶ 13.6 & Ex. I., § 19/2.
24
See Ex. A, Tr. 8/11 Hr’g, 224:5-224:16.
25
See Ex. J, p. 3.
26
See Scheduling Order entered in UMC Adversary [Adv. Dckt. No. 22].
23
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reorganization that UMC is willing and able to subordinate its claims to those of other creditors
for some time); whereas the potential injury to the Debtor and the El Paso community should the
Court grant the Motion is exponential given that the Debtor will be left unable to operate
independent of UMC,27 and given that UMC’s operation or joint-operation of the Debtor will
denigrate the quality of the medical facilities and services the Debtor provides to the children and
indigent of El Paso.
14.
Any one of the foregoing reasons establishes that the Motion should be denied.
II. FACTUAL BACKGROUND
15.
On May 19, 2015 (“Petition Date”), the Debtor filed its voluntary petition for
relief under chapter 11 of the United States Bankruptcy Code, 11 U.S.C. § 101, et seq., as
amended (“Bankruptcy Code”). The Debtor is a debtor-in-possession pursuant to §§ 1107(a) and
1108 of the Bankruptcy Code. No request for the appointment of a trustee or examiner has been
made in this bankruptcy case, and no committee has been appointed or designated.
16.
A description of the background of the Debtor and the events leading up to the
filing of the voluntary petition by the Debtor is provided in the Declaration of Mark Herbers in
Support of First Day Motions, which is incorporated herein by reference.
17.
The Debtor is an independent non-profit 501(c)(3) corporation that is governed by
a board of directors (“EPCH Board”). Its sole mission has been, and continues to be, to provide
care to the children of El Paso and the surrounding areas. The Debtor’s primary operations have
consisted of owning and operating a 122-bed children’s hospital.
18.
Days before opening its doors to patients, the Debtor entered into the Lease, a true
and correct copy of which is attached hereto as “Exhibit I.” The Lease provides for a term of
27
See Ex. A, Tr. 8/11 Hr’g 180:22-24.
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360 months (or 30 years).28 The “Premises” is the property upon which the Debtor conducts all
of its operations, and is located on the UMC campus.
19.
On July 8, 2015, the Debtor filed its First Amended Complaint (“Complaint”)
against UMC, initiating Adversary No. 15-03005 (herein “UMC Adversary”). Among other
things, by the Complaint, the Debtor seeks to avoid the UCC-1 (“UMC Lien”) asserted by UMC
pursuant to §§ 547 and 548 of the Bankruptcy Code; and seeks a declaratory judgment under
both Federal law and Texas law concerning the Lease, setting forth that the Lease is a disguised
financing transaction and not a “true lease.” See Complaint, ¶ 133.
20.
In the Complaint, the Debtor also set forth that the Lease “is a transaction through
which [UMC] sought to finance obtainment or entitlement to certain governmental funds.” The
Debtor also set forth therein that UMC insisted upon the Debtor entering into the Lease “with the
highest rental rate that could be supported by a valuation, intended the Lease to function as a
financing transaction.” See Complaint, ¶ 134. The Complaint states that UMC “structured the
Lease such that the rental amounts collected by Defendant be used to fund an intergovernmental
transfer to the State, allowing federal matching funds to be obtained for the benefit of Plaintiff
who could then use such funds to pay amounts owed under the Lease.” See Complaint, ¶ 134.
Further, the Debtor’s financial obligations under the Lease “are not based on the true rental value
of the Premises.” See Complaint, ¶ 135.
21.
On July 23, 2015, UMC filed its Limited Objection to Debtor’s Emergency
Motion Pursuant to 11 U.S.C. § 363 for (I) Authority to Use Cash Collateral in the Ordinary
Course; (II) Provide Adequate Protection; and (III) Scheduling Final Hearing, [Dckt. #186]
28
See Ex. I, § 1.3
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(“Objection to Cash Collateral”),29 by which UMC argued, in part, that § 365(d)(3) does not
permit the Debtor to use cash collateral. See Objection to Cash Collateral, ¶¶ 13-18. Obligated
to respond to the assertions made therein, on July 29, 2015, the Debtor filed its Response to the
Objection to Cash Collateral, [Dckt. #201], which argued that the issue of cash collateral usage
did not implicate any issue under § 365(d)(3), and that, at any rate, the Lease was not a true lease
to which § 365(d)(3) applies. See Response to the Objection to Cash Collateral.
22.
On July 30, 2015, the Court conducted a hearing on the Cash Collateral Motion,
including UMC’s Objection thereto (“Cash Collateral Hearing”).
At the Cash Collateral
Hearing, the Debtor elicited the testimony of two witnesses, including Ray Robert Dziesinski
and Sam Legate. Both provided uncontroverted testimony proving that the Lease is not a true
lease. Because the Lease is not a true lease, UMC cannot seek to compel the Debtor to pay
amounts under § 365(d)(3). UMC cannot assert the § 365 rights of a landlord in this bankruptcy
case when the Lease is undisguised financing and should be renegotiated under its various force
majeure and good faith renegotiations provisions. The relationship between UMC and the
Debtor is complex, intertwined, and unusual. It does not fit within the typical framework of a
landlord/tenant relationship or even a creditor/debtor relationship, and UMC’s efforts to create a
fictional framework to advantage itself at this juncture should fail based upon the undisputed
facts in this case.30 The Motion should be denied.
29
The Objection was filed to the Debtor’s Emergency Motion to Use Cash Collateral (“Cash Collateral
Motion”) [Dckt. #3].
30
See Debtor’s Objection to El Paso County Hospital District d/b/a University Medical Center of El Paso’s Motion
to Terminate Exclusivity Periods Pursuant to 11 U.S.C. § 1121(d), pp. 6-8.
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III. ARGUMENT & AUTHORITIES
A.
Abundant Evidence Demonstrates that the Rent is Contingent on IGT Funding and
§ 365(d)(3) is Wholly Inapplicable
23.
UMC cannot reasonably seek affirmative relief with respect to the Lease because
§ 365(d)(3) does not apply under these circumstances. Although UMC attempts to portray itself
as a garden-variety landlord entitled to various protections under § 365, UMC did not enter into
the Lease as a garden-variety landlord. UMC cannot now attempt to use § 365(d)(3) to force the
Debtor to hemorrhage cash to UMC under the guise of rental payments that it (i) did not expect
from the Debtor and (ii) that are not actually payments of rent under a true lease. UMC, unlike a
typical landlord, did not pay for the Premises, pays no financing costs for the Premises, and is
triply compensated under the Additional Rent and ancillary agreements for any marginal costs.31
Lease recharacterization is typical in public financing arenas because of the atypical economics
of public financing. See City of San Francisco Market Corp. v. Walsh (In re Moreggia & Sons,
Inc.), 852 F.2d 1179 (9th Cir 1988) (holding that a lease was not subject to § 365(d)(4) when
such lease had been put in place by the City of San Francisco in relationship to a development
project created to help private businesses displaced by the project); United Airlines, Inc. v. HSBC
Bank USA, N.A. 416 F.3d 609 (7th Cir. 2005) (recharacterizing agreement as a disguised
financing agreement based in part on fact that rental payments were tied to the amount borrowed
from bondholders). In United Airlines Inc. v. U. S. Bank National Association, Inc. 447 F.3d 504
(7th Cir. 2006)(recharacterization lease airline entered into with bond-issuing public entity in
part, on basis that rental payments tied to amount borrowed from bondholders).
24.
Courts agree that the Bankruptcy Code “mandates that a court look beyond mere
form the circumstances of each case, including the economic substance of the transaction, to
31
See Ex. B, Tr. 7/30 101:6-20 (Mr. Legate testified that UMC’s costs for maintaining the Leased Premises are zero
as the payment of maintenance and utilities is made by the Debtor under various of the Agreements).
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determine whether a ‘true lease’ exists for purposes of the Code.” In re PCH Assocs., 804 F. 2d.
193, 198 (2d Cir. 1986). In PCH Associates, the Second Circuit affirmed the bankruptcy court’s
ruling that an agreement purporting to be a lease was actually a joint venture, developed to
provide the means by which investment goals and tax requirements of the parties would be
satisfied. In PCH Associates, the Second Circuit ruled that because the agreement was not a true
lease for purposes of the Bankruptcy Code, §§ 365(d)(3) and (4) did not apply. Id. at 199-200.
25.
When evidence exists upon which the Court can question the true nature of a
document masquerading as a lease, authority supports suspension of a debtor’s performance
under a lease otherwise required under § 365(d)(3). In re Mirant Corp., 2004 Bankr. LEXIS
1377 (Bankr. N.D. Tex. Sept. 15, 2004); see United Airlines, Inc., 416 F.3d 609 (7th Cir. 2005).
In Mirant Corp., 2004 Bankr. LEXIS 1377, *2 (Bankr. N.D. Tex. Sept. 15, 2004), Judge Lynn
examined an argument by the debtor in response to a motion to compel payment of rent filed
under §§ 365(d)(3) and § 365(d)(5), in which the debtors argued that the leases were disguised
security agreements. He stated that he did not have “sufficient evidence” to rule that the leases
were not true leases within the meaning of § 365(d), but he expressly left open whether a debtor
may avoid compliance with § 365(d)(3) pending resolution of a “true lease” issue. Id. at *10.
26.
Although Judge Lynn denied the debtors’ request in Mirant Corp, he did so in the
context of pragmatic reasoning that examined the effect on the debtors’ estates of ordering
compliance with §§ 365(d)(3) and (d)(5). See Mirant Corp., 2004 Bankr. LEXIS 1377 at *13.
In so doing, Judge Lynn pointed out that if the leases at issue there turned out to be financing
transactions, then the putative landlords would be secured creditors. Id. Thus, any monies paid
by the debtors to the putative landlords would have the effect of reducing the estates’ secured
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obligations. Id. Based on the effect on the debtors’ estates, Judge Lynn concluded that ordering
compliance with §§ 365(d)(3) and (d)(5) did not impose a “significant risk.” See id.
27.
The instant case is exactly the type of case in which compliance with §§ 365(d)(3)
(or any other provision of § 365) should not be required of the Debtor, as alluded to by Judge
Lynn in Mirant Corp. Here, unlike the case in Mirant, overwhelming and uncontroverted
evidence already before this Court shows that the Lease is not a true lease, and the parties
believed no amounts would be paid by the Debtor during this time frame. As set forth above, the
Master Agreement itself, executed in 2012, demonstrates that the parties contemplated
adjustments to the rent figure included in the Lease to account for changes in government
funding.32 In addition, UMC itself anticipated no amounts from the Debtor for rent in 2015 as it
has publicly acknowledged.33
28.
Thus, the evidence in this matter is more than just the pending UMC Adversary,
and includes admissions by UMC that no rent was anticipated from the Debtor in fiscal year
2015 – the present time. As set forth further herein, Ray Robert Dziesinski and Sam Legate have
already testified in this case that no rent should be due to UMC.34 Their testimony has provided
abundant facts to support the conclusion that the Lease is not a true lease. As contemplated in
Mirant Corp., the Debtor can readily prove that UMC is not a party to a true lease requiring
rental payments. See id. at *13. Accordingly, the Debtor should not be required to comply with
the provisions of § 365 applicable to leases.
B.
Denial of UMC’s Motion Pending Judgment in the UMC Adversary is Procedurally
Appropriate
32
See Ex. G. § 15.23(b).
See Ex. K, p. 4, El Paso County Hospital District Fiscal 2015 Proposed Operating and Capital Budget Executive
Summary and Budget Assumptions (UMC set forth that “Service and lease-type arrangements with the El Paso
Children’s approximate $28 million; however, no cash receipts from El Paso Children’s are anticipated in 2014.”).
34
See Ex. B, Tr. 7/30 Hr’g, 45:1-5 & 99:4-17.
33
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29.
Part of the Debtor’s claims to be tried in only approximately two months in the
UMC Adversary is the Debtor’s request that the Lease be recharacterized. Given the pendency
of the UMC Adversary, and the pending request to recharacterize the Lease therein, denial of the
Motion is appropriate until judgment is entered in the UMC Adversary. Whatever interest that
UMC may have in the Premises is more than adequately protected by virtue of the Debtor’s
ongoing payments to UMC in this case that more than compensate UMC for utilities and
maintenance of the Premises.35
30.
Logically, the threshold issue of whether the Lease is a “true lease” should be
decided before any analysis under § 365. See e.g., GE Capital Corp., Inc. v. Sylva Corp. (In re
Sylva Corp.), 519 B.R. 776, 783 (8th Cir. 2014). Section 365(d)(3) applies only to “true’ leases
of commercial property that are unexpired on the petition date.” In re Imperial Bev. Group,
LLC, 457 B.R. 490, 496 (Bankr. N.D. 2011).
31.
In GE Capital Corp. v. Collins & Aikman Corp. (In re Collins & Aikman
Corporation), 351 B.R. 459 (E.D. Mi. 2006), the bankruptcy court denied a creditor’s motion to
compel payment of rent and taxes pursuant to § 365(d)(5). The debtors there had initiated an
adversary proceeding to recharacterize the purported leases subsequent to the creditor’s renewed
motion to compel payment of rent. Id. at 461. To address the motion to compel, the bankruptcy
court cited the pending adversary in which the question of whether the purported lease should be
recharacterized would be fully litigated and scheduled a hearing at which each side could make
an “offer of proof” and present its case as to recharacterization. Id. at 462. Ruling after such
35
Pursuant to the Agreed Fourth Interim Order (I) Authorizing Use of Cash Collateral; (II) Providing Adequate
Protection; and (III) Scheduling Final Hearing (“Cash Collateral Order”) [Dckt. #209], the Debtor is making
adequate protection payments of $150,000 per month to UMC, in addition to the approximately $1.2 million the
Debtor is paying on a post-petition monthly basis to UMC. In addition, UMC also received two payments of
$500,000 each, totaling $1,000,000.00 from the Debtor pursuant to the Third Interim Order (I) Authorizing Use of
Cash Collateral; (II) Providing Adequate Protection Payment; and (III) Scheduling Final Hearing [Dckt. #144].
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hearing, the court concluded that it was “more likely than not” that the purported agreements
would be recharacterized as financing transactions. Id.
32.
The bankruptcy court denied the creditor’s motion to compel. Id. On appeal, the
district court expressly agreed with the approach utilized by the bankruptcy court of receiving
some evidence on the purported lease, noting that applicable provisions of § 365 provide no
procedures for resolving motions to compel performance in the face of a challenged lease. Id. at
469, n.9. The district court also emphasized that the creditor could have pursued adequate
protection payments to safeguard its interest while awaiting a ruling on whether § 365(d)(5)
applied. Id. at 468. The court also emphasized the lack of cited authority for the proposition that
the bankruptcy court should presume that the agreements were true leases and order compliance
with them “without affording [d]ebtors any opportunity to make a prima facie showing, at least
that this statutory provision was not applicable.” Id. at 468. Indeed, the court observed that
§365(d)(5) itself authorizes the bankruptcy court to relieve a debtor-in-possession from timely
performance under a lease “after notice and a hearing and based on the equities of the case.” Id.
33.
The Collins & Aikman Corp. court readily concluded that such “equities” should
include the likelihood that the purported lease would be recharacterized as a secured financing
transaction. Id. at 468-69. The same reasoning should apply to the instant matter. Given the
pendency of the UMC Adversary, and the Debtor’s request therein to recharacterize the Lease
made prior to the filing by UMC of the Motion, as well as the evidence supporting
recharacterization already in the record in this matter (as further argued below), the Debtor
should not be obligated to perform under the terms of the Lease as requested in the Motion until
judgment is entered against it in the UMC Adversary.
C.
The Record in this Case Demonstrates that the Agreement is Not a True Lease
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34.
The record in this bankruptcy case proves that the Lease is not a true lease. As set
forth above, at the Cash Collateral Hearing, the Debtor elicited the testimony of two witnesses,
including Ray Robert Dziesinski and Sam Legate. The testimony of both Messrs. Dziesinski and
Legate demonstrate that the Lease is not a true lease, and instead is a disguised financing
transaction to which no provision of § 365 applies.
(a)
Testimony of Mr. Dziesinski
35.
At the Cash Collateral Hearing, Mr. Dziesinski testified that he served as the
interim chief executive officer for the Debtor for six months.36 Mr. Dziesinski testified in
particular that the Lease was a “bond funded” item on an agenda of agreements between the
Debtor and UMC.37
He also testified that the “Document Acknowledgment,” and the
accompanying spreadsheet included no amount for rent to UMC. To that end, Mr. Dziesinski
testified in particular, as follows:
Q.
Under the fiscal year ’15 and fiscal year ’14 columns, do you see the cash
basis for the lease is blank?
A.
Yes.
Q.
Does that mean zero?
A.
It is intended to mean zero.38
Describing the obligation under the Lease in further detail, Mr. Dziesinski went on to testify as
follows:
[T]he viewpoint of the governing body of El Paso
Children’s Hospital is that this is not a cash cost to
University Medical Center. The citizens of El Paso County
have funded this both principal and interest and, therefore,
[] it’s a binary choice. So, putting any amount in there
36
See Ex. B, Tr. 7/30 Hr’g, 39:14-15.
See Ex. B, Tr. 7/30 Hr’g, 44:11-19.
38
See Ex. B, Tr. 7/30 Hr’g, 45:1-5 (emphasis added).
37
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might be inferred as a renegotiation when, is it due or is it
not due.
Q.
And what is the choice that’s reflected in this spreadsheet?
A.
The choice is reflected in that it is not due. . .39
On cross-examination, Mr. Dziesinski emphasized that the amounts purportedly due under the
Lease did not represent any reimbursement to UMC for costs incurred by it associated with the
Debtor’s use of the Premises:
Q.
So I understand, sir, what you’re saying is that in your opinion the dash or
the zero was intended to show what amount EPCH thought it was capable
of paying in fiscal year 2015 for the base rent?
A.
Capable and was philosophically willing to pay because of the argument
that the money was not out of the UMC pocket, it had already been paid
for by the bondholders, which is part of the larger debate that was taking
place at that time.40
The evidence demonstrates that the parties engaged in renegotiation concerning the amount due
from the Debtor to UMC under the Lease. In addition, the evidence demonstrates that the
Premises under the Agreement was not paid for by UMC, but instead was paid for by the
bondholders and ultimately the El Paso taxpayers. Finally, the testimony of Mr. Dziesinski
establishes that the parties had agreed that no amount, indeed “zero,” would be paid by the
Debtor to UMC pursuant to the Lease at this time.
(b)
Testimony of Sam Legate
36.
In addition, Mr. Legate testified at the Cash Collateral Hearing. Mr. Legate
testified as to his background with both the Debtor and UMC, as follows:
In 2000 or 2001, I can’t remember which year, I went on the board
of El Paso Hospital District and I served as vice chair for, I don’t
know, five or six years and I went off that board in 2007, when we
39
40
See Ex. B, Tr. 7/30 Hr’g, 46:3-11 (emphasis added).
See Ex. B, 7/30 Hr’g, 65:10-17 (emphasis added).
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- - then we formed the Children’s Hospital Board shortly after
that.41
Mr. Legate testified that the Debtor entered into a series of agreements with UMC.42 In addition,
Mr. Legate testified as follows:
Q.
And there was a Master Agreement?
A.
Yes, sir.
Q.
And a lease?
A.
Yes, sir, that was part of the Master Agreement.43
He also testified with respect to his particular role related to the execution of the Agreements,
including the Lease. He testified as follows:
Q.
What was your role with respect to discussions about the
lease agreement between the parties?
A.
Well, you know, I think if everyone testifies truthfully
they’ll know I never agreed we had a lease agreement, that
the taxpayers built the building for the benefit of the
Children’s Hospital, they didn’t build it as a windfall for
UMC to collect 8 million a year, that I never - - I never,
ever, ever, ever agreed to a lease. I finally was convinced
that we - - to have a lease, because it facilitated an IGT,
you know, some governmental financing, and in the
agreement that we had with them at my insistence is that if
that financing of that mechanism that we agreed to have a
lease was ever disrupted, that we would renegotiate the
lease or redo the lease or have it go away.44
Mr. Legate also testified as to the purpose of the Lease from the perspective of both UMC and
the Debtor prior to the Debtor’s opening:
Q.
Was there an appraisal done of the fair market value of the
space?
41
See Ex. B, Tr. 7/30 H’rg, 89:8-12.
See Ex. B, Tr. 7/30 H’rg, 95:25-96:3.
43
See Ex. B, Tr. 7/30, H’rg 96:4-7 (emphasis added).
44
See Ex. B, Tr. 7/30 H’rg, 99:4-17.
42
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A.
There were some numbers presented. To be candid with
you, I can’t even honestly say I paid much attention. I
think Mr. Sosa went out and got some numbers and Larry
went out and got some numbers and they kind of just said,
okay, this seems like it will pass the muster.
Q.
And by “pass the muster,” you mean that the lease was
going to be reviewed by someone at some time?
A.
I think it needed to be a legitimate transaction for the
federal government, or the funding from Health and Human
Services.45
He further testified as to the parties’ understanding that the Lease had to be in place, testifying on
cross-examination as follows:
Q.
And it doesn’t say that there wouldn’t be a lease obligation
at all, correct?
A.
No. But there were conversations about that the lease had
to be there, “Just trust me.” That would be Mr. Valenti’s
words, “Just trust me.”46
Mr. Legate testified that no costs accrue to UMC for the Debtor’s use of the Premises, testifying
that “if the service contracts are being paid, then UMC’s out no money for the building.”47 Mr.
Legate also testified as to provisions of the Master Agreement and Lease that require
renegotiation based on changed circumstances. In this vein, he testified as follows, with respect
to § 15.23(b) of the Master Agreement:
Q.
Was this one of the provisions that you had requested to
account for the potential changes in funding available to the
Children’s Hospital?
A.
I insisted that it be in there.
Q.
After the parties signed the lease, Mr. Legate, did the event
or events of the type described in Subsection (b) of the
Master Agreement occur?
45
See Ex. B, Tr. 7/30 H’rg, 100:19-101:5
See Ex. B, Tr. 7/30 H’rg, 135:21-25.
47
See Ex. B, Tr. 7/30 H’rg, 101:18-20.
46
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A.
Yes.
Q.
How so?
A.
The funding for - - well, initially the Children’s Hospital
was cost-based, the funding was cost-based, so if you had
$100 in bills, let’s say, you could get reimbursed at 80.
And so there was a certain incentive for both parties for the
costs to be maybe higher than they should have been later
and that was kind of the recognition that if the cost-based
reimbursement went away, which it did very quickly after
these agreements were done, then all this would have to
be redone.48
(c)
Testimony of UMC’s Board of Managers Chairman, James Stephen DeGroat
37.
The testimony of UMC’s own representatives reveals that the Lease represents an
attempt to accomplish something other than compensate UMC for its costs associated with the
Premises, as would be true under a true lease. The Debtor has conducted a 2004 examination of
James Stephen DeGroat. Mr. DeGroat is presently serving as the Chairman of the Board of
Managers of UMC, and previously served on the Board of Directors for El Paso First, as well as
the Board of Directors for the Debtor. Relevant excerpts of such 2004 examination are attached
hereto as “Exhibit I.” In his 2004 examination, Mr. DeGroat testified as follows about the Lease:
48
49
Q.
But generally it’s your understanding that the triple net
obligations under the facility lease are in addition to the
$860,000 a month that’s owed?
A.
Yes.
Q.
How much of the $860,000 a month do you believe is
attributable to depreciation?
A.
The majority of it.49
See Tr. 7/30 H’rg, 107:19-108:10 (emphasis added).
See Ex. F, Tr. 55:7-13.
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Mr. DeGroat went on to further testify that “UMC is entitled to a lease payment that equals fair
market value as determined by third-party experts.”50 Mr. DeGroat testified that the rent charged
under the Lease was “primarily for depreciation,” and further testified as follows:
38.
Q.
How does depreciation relate to fair market value?
A.
I have no idea.51
As demonstrated by Mr. DeGroat’s testimony in his 2004 examination, UMC
incurred no cost in building the premises as such was paid for 100% by the taxpayer bonds. Mr.
DeGroat’s testimony also demonstrates that although UMC’s position is that the rent under the
Lease is based upon an alleged “fair market value,” UMC “has no idea” of how depreciation
relates to fair market value under the Lease. These facts and the parties’ obligations under the
Master Agreement to adjust the rent under the Lease because of changed economics, readily
demonstrate that the Lease is not a true lease subject to § 365.
D.
The Debtor May Seek to Have the Claim of UMC Estimated to Facilitate Quick
Administration of this Bankruptcy Case
39.
Section 502(c) provides a mechanism for the estimation of any claim owed by the
Debtor to UMC in this bankruptcy case when the failure to do so would unduly delay the
administration of this bankruptcy case. As set forth in In re Mirant Corp., 2004 Bankr. LEXIS
2576, at *10-11, bankruptcy courts permit the estimation of claims when necessary to prevent
delay in the closing of a bankruptcy case. (citing Carlson v. U.S. (In re Carlson),126 F.3d 915,
926 (7th Cir. 1997); In re National Gypsum Co., 139 B.R. 397, 405, n. 19. (N.D. Tex. 1992)
(noting that estimation of claims prior to confirmation of a plan is necessary for evaluation of
plan feasibility and to avoid delay of confirmation)). Even contingent, post-petition claims may
be liquidated under § 502(c). See In re MacDonald, 128 B.R. 161 (Bankr. W.D. Tex. 1991). As
50
51
See Ex. F, Tr. 57:1-3.
See Ex. F, Tr. 58-25:59-2.
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noted by the court in MacDonald, “courts have nonetheless assumed that the estimation process
in § 502(c) may be equally employed for estimating post-petition claims, when necessary to
avoid delaying the administration of the bankruptcy case.”).
40.
Accordingly, the Motion can be denied because payment of any amount to UMC
under the Lease can be adjudicated via a claims estimation process to facilitate administration of
this case and support the Debtor’s confirmation of a chapter 11 plan. Although the Debtor
vehemently believes no amount is owed to UMC on any basis, including a post-petition basis,
with respect to the Lease, any such claim can be estimated consistent with § 502(c). The Motion
should be denied.
E.
UMC Anticipated No Rental Payments From the Debtor at this Time
41.
Based upon applicable contracts and the parties’ agreement from the beginning
of their relationship, and contrary to UMC’s position in its Motion, no amount for rent is due to
UMC for the Debtor’s use of the leased premises. In fact, unlike typical commercial lesser and
lessees, the parties contemplated that the amount of rent due under the Lease might necessarily
change from the very beginning. The Debtor and UMC are parties to the Master Agreement,
dated February 1, 2012.52 Section 15.23(b) expressly provides for the parties to revise amounts
due under the Lease:
If following the Closing Date there occurs material changes in an
applicable healthcare law or the interpretation thereof, including
without limitation, Medicare and Medicaid laws, regulations, and
instructions promulgated there under (including reimbursement
amounts or methodology), or government programs funding
indigent care and/or in the indigent population seeking care within
El Paso County, which materially increases the financial burden on
the DISTRICT or EPCH relative to its compliance with this
Agreement and the Related Agreements, taken as a whole, beyond
which is reasonably to be anticipated by an experienced operator of
health facilities as of the Closing Date, and which change is not
52
See Ex. G.
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within the control of, and the effect of which cannot be avoided by,
such adversely affected party, then at the request of the adversely
affected party, the two parties hereto shall use their respective
reasonable efforts to negotiate in good faith to adopt
amendments to this Agreement and the Related Agreements,
including adjustments, if any, to the Rent due under the Lease, to
take such changes into account.53
It is undisputed that material changes in healthcare law described above did in fact occur.
Consistent with the Master Agreement, the Debtor and UMC agreed in September 2014 that the
Debtor would not pay any amounts for rent to UMC (“2014 Amendment”).54
The 2014
Amendment sets forth that UMC and the Debtor agreed to revisions in various contracts effective
as of fiscal year 2015.55 The spreadsheet attached to the 2014 Amendment demonstrates no
amount due for rent under the Lease to UMC.56
42.
UMC itself has behaved consistent with the parties’ agreement that no rent would
be paid during this time. Most notably, in the published version of UMC’s Fiscal 2015 Proposed
Operating and Capital Budget Executive Summary and Budget Assumptions (“UMC 2015
Budget”), UMC plainly set forth that it anticipated nothing would be paid by the Debtor.57 UMC
set forth as follows:
Service and lease-type agreements with the El Paso Children’s
approximate $28 million; however, no cash receipts from El Paso
Children’s are anticipated in 2014.58
Despite the Debtor’s nonpayment of rent, UMC has never initiated any eviction or termination
action against the Debtor, and instead has characterized the Lease (prior to this bankruptcy
53
See Ex. G at § 15.23(b) (emphasis added).
See Ex. H.
55
See Ex. H.
56
See Ex. H, p. 2.
57
See Ex. K
58
See Ex. K, p. 3.
54
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proceeding) as merely a “lease-type agreement.”59 UMC’s demand for rental payments and its §
365-based assertions in this bankruptcy case represent a departure from the parties’ agreements,
UMC’s own apparent understanding about the “lease-type agreements,” and the 2014
Amendment. No rental payment was expected by UMC from the Debtor during this year and the
Debtor should not now be made to pay what it does not owe, solely to satiate UMC in this
bankruptcy case.
43.
In a remarkably similar case, in City of San Francisco Market Corp. v. Walsh (In
re Moreggia & Sons, Inc.), 852 F.2d 1179 (9th Cir 1988), the Ninth Circuit considered a debtor’s
agreement for two store units in a produce terminal in San Francisco with the City of San
Francisco; the rent under the agreements at issue equaled the funds necessary to retire bond debt
owed by San Francisco Market Corp, and once paid off, no rent would be due from the debtor.
At the time of the debtor’s chapter 11 petition, the bond debt had already been paid off, and the
debtor no longer owed any rental obligation. Id. After conversion to chapter 7, San Francisco
Market Corp. opposed a sale effort, arguing that the chapter 7 trustee had failed to assume the
lease within the time frame required by § 365(d)(4). Id. The bankruptcy court determined that
the lease was not governed by § 365(d)(4).
44.
On appeal, the Ninth Circuit affirmed the bankruptcy court’s ruling. Id. In so
doing, the Ninth Circuit agreed that the agreement at issue constituted a lease under California
state law, but held that compliance with § 365(d)(4) was inappropriate based upon the
“economic realities” of the arrangement.” Id. (emphasis added). In so doing, the Ninth Circuit
observed that distinctions should be made under the Bankruptcy Code for true leases and
financing transactions. Id. (citing S. Rep. No. 989, 95th Cong., 2d Sess. 64, reprinted in 1978
59
See Ex. K, p. 3
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U.S. Code Cong. & Admin. News 5787, 5850). The Ninth Circuit also commented that the lease
was “unusual” and arose under “unique circumstances,” and characterized the transaction as
“peculiar.” Id. at 1184. In particular, the Ninth Circuit concluded that “[n]o true landlord/tenant
relationship was ever intended or created,” and that the produce terminal had been created to
allow the City of San Francisco to fulfill a legal obligation to provide relocation space to
businesses such as the debtor. Id.
45.
Importantly, the Ninth Circuit also recognized that the San Francisco Market
Corp. “suffered no delay, uncertainty, or other harm as a result of the failure to assume expressly
the lease within the 60-day period.” Id. at 1185. Emphasizing the equitable powers of the
bankruptcy court, the Ninth Circuit held that § 365 leases had to be true or bona fide leases based
on the economic substance of the transaction.
46.
The economic realities of the transaction related to the Lease compel the same
result here. The uncontroverted evidence demonstrates that the Lease was entered into under
peculiar and unique circumstances by UMC and the Debtor, similar to Walsh, not to facilitate a
landlord/tenant relationship but rather, to facilitate receipt of federal funds in the form of
anticipated intergovernmental transfers. As set forth above, Mr. Legate testified expressly that
the Lease had to be a “legitimate transaction for the federal government or the funding from
Health and Human Services.”60 He also testified that he had been convinced that an agreement
denominated a lease had to be in place “because it facilitated an IGT.”61
47.
In addition, as in Walsh, the payment of rent to UMC does not represent payment
relating to UMC’s cost for the Premises, as such amounts were fully paid for by the bonds
approved by El Paso’s taxpayers. Indeed, as with the produce terminal in Walsh, the Premises
60
61
See Ex B, Tr. 7/30 H’rg, 100:19-101:5.
See Ex. B., Tr. 7/30 H’rg, 99:4-17.
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were equipped and built out for the express purpose of fulfilling the establishment of a children’s
hospital in El Paso based upon taxpayers’ vote in support.62 The economic realities of the
transaction between the Debtor and UMC relative to the Lease overwhelmingly demonstrate that
compliance with any provision of § 365 is not appropriate. UMC’s Motion should thus be
denied.
F.
Requiring Compliance with § 365(d)(3) in the Face of the Evidence Demonstrating
the Agreement Should Be Recharacterized Unnecessarily Puts the Debtor at
Substantial Risk
48.
Employing the reasoning in Mirant Corp., the potential risk from requiring
compliance with § 365(d)(3) demonstrates that no such compliance should be required pending
resolution of the UMC Adversary. Requiring the Debtor to pay the amounts demanded as UMC
puts the Debtor at significant risk of illiquidity and threatens its ongoing operations while
allowing UMC to escape judicial scrutiny, which UMC knows. The uncontroverted evidence is
that UMC is already receiving three times its actual costs in the existing cash collateral budget.
The creation of this risk, of course, compliments UMC’s motive as laid bare in its desire to file
its own plan of reorganization in this bankruptcy case. UMC seeks to complete its hat trick of
(a) fomenting support for an independent children’s hospital to obtain full financing for its
construction; (b) forcing the Debtor on the eve of opening to sign a lease above and beyond the
Debtor’s ability to pay on the false promise of IGT and good faith renegotiations; and then
(c) using that fake debt to control the Debtor – even in its bankruptcy case.
49.
By requesting that the Debtor be required to comply with § 365(d)(3) for the
disputed Lease – in the face of the fact that UMC anticipated no rental payments from the Debtor
during fiscal year 2015 – UMC seeks to pave an alternate route for its ownership of the Debtor
on its own terms beneficial chiefly to it. The risk could not be more substantial for the Debtor
62
See Ex. A, Tr. 8/11 H’rg 169:15-170-22.
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and its estate. Applying the logic of Mirant Corp., and given that the Debtor’s reorganization
would be at substantial risk, compliance with § 365(d)(3) should be suspended pending the
Court’s resolution of the UMC Adversary.
50.
In Wells-Fargo Equip. Fin. v. Circuit-Wise (In re Circuit-Wise, Inc.), 277 B.R.
460, 463-64 (Bankr. D. Conn. 2004), the court, in ruling that § 365(d)(3) did not apply when a
lease was disputed as not a true lease, stated that appropriate measures could be put in place to
protect the interests of a putative lessor while the lease issue was being adjudicated sufficient to
satisfy the putative lessor’s concerns related to § 365(d)(3). Such measures include the granting
of the putative lessor’s request for an expedited trial on the lease issue, the posting of additional
security by the debtor to protect the lessor in the event the lessor prevails on the lease issue; and
an award of attorneys’ fees if pleadings attacking the lease were filed solely to circumvent
§ 365(d)(3) with no basis in law or fact. See id.
51.
All such measures enumerated by the court in Circuit-Wise are already in place in
this case. Here, at the request of the Debtor, the Court has set forth an expedited scheduling
order for the UMC Adversary pursuant to which a trial is little more than two months away.63 In
addition, the Debtor is paying amounts to UMC for services, maintenance and utilities that are
three times or more than UMC’s costs.64 The Debtor’s use of the Premises costs UMC nothing,
and UMC is being paid more than its actual costs for providing any other contracted services or
Additional Rent.65 Finally, both law and fact support the Debtor’s allegations concerning the
Lease, including UMC’s own public statement that it anticipated no rental payments from the
63
See Scheduling Order [Adv. Dckt. No. 22].
See Fourth Interim Cash Collateral Order & Ex. A, 50:11-23; 51:14-52:6 (Mr. Herbers testified that UMC is being
paid approximately $820,000 above cost for services provided by UMC to the Debtor.).
65
Ex. A, Tr. 8/11 Hr’g 50:11-23; 51:14-52:6.
64
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Debtor during fiscal year 2015 – the same time frame for which now seeks payments from the
Debtor in its Motion.66
G.
Under the Parties’ Agreements, the Debtor Has No Obligation to Pay Base Rent
under the Lease for Years 2014 and 2015.
52.
The law does not require the Debtor to perform any post-petition nonresidential
lease obligations until such lease is assumed or rejected when no such obligations exist in the
first place.
See GE Capital Corp. v. Collins & Aikman Corp. (In re Collins & Aikman
Corporation), 351 B.R. 459 (E.D. Mi. 2006). Consistent with the provisions of the Lease and
the parties’ other agreements, the Debtor has paid no Base Rent to UMC during the pendency of
this bankruptcy case because UMC was not, and is not, entitled to any such payments. In the
Motion, UMC offers an unreasonable interpretation of the Lease Agreement that fails to address
material provisions within its four-corners, and those provisions, together with admissible
extrinsic evidence, establish that the Debtor is not obligated to pay the Base Rent amounts UMC
alleges are owed thereunder.
(a)
Principles of Contract Interpretation Favor the Debtor’s Position
Concerning the Lease.
53.
The principles of contract interpretation are well-settled under Texas law. The
Court may construe an unambiguous contract as a matter of law. Coker v. Coker, 650 S.W.2d
391, 393 (Tex. 1983). It is axiomatic that when construing a contract, the Court’s paramount
objective “is to ascertain the true intentions of the parties as expressed in the writing itself.”
Kachina Pipeline Co. v. Lillis, 58 Tex. Sup. J. 1005, No. 13-0596, 2015 Tex. LEXIS 549, at *8
(Tex. June 12, 2015); Coker, 650 S.W.2d at 393. To achieve that objective, the Court may
utilize several rules of interpretation, which include the following:
66
See Ex. K.
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The contract “must be construed to give effect to the parties’ intent
expressed in the text as understood in light of the facts and
circumstances surrounding the contract’s execution, subject to the
limitations of the parol-evidence rule.” Americo Life, Inc. v. Myer,
440 S.W.3d 18, 22 (Tex. 2014); see Kachina Pipeline Co. v. Lillis,
58 Tex. Sup. J. 1005, No. 13-0596, 2015 Tex. LEXIS 549, at *8
(Tex. June 12, 2015). “Facts and circumstances that may be
considered include the commercial or other setting in which the
contract was negotiated and other objectively determinable factors
that give context to the parties’ transaction.” Kachina Pipeline,
2015 Tex. LEXIS 549 at *9; Coker, 650 S.W.2d at 393.
•
•
“[E]xamine the entire agreement and give effect to each provision
so that none is rendered meaningless.”67 Americo Life, 440 S.W.3d
at 22; see Kachina Pipeline, 2015 Tex. LEXIS 549 at *8.
•
“[G]ive contract terms their plain and ordinary meaning unless the
instrument indicates the parties intended a different meaning.”
Kachina Pipeline, 2015 Tex. LEXIS 549 at *9.
•
Consider all portions of the contract together and give meaning to
each part “as will carry out and effectuate to the fullest extent the
intention of the parties”68 City of Pinehurst v. Spooner Addition
Water Co., 432 S.W.2d 515, 519 (Tex. 1968).
•
“Construe a contract from a utilitarian standpoint, bearing in mind
the particular business activity sought to be served.” Kachina
Pipeline, 2015 Tex. LEXIS 549 at *9 (quotations and citations
omitted).
54.
A contract is unambiguous if it “is so worded that it can be given a certain or
definite legal meaning or interpretation.” Coker, 650 S.W.2d at 393. “A contract, however, is
ambiguous when its meaning is uncertain and doubtful or it is reasonably susceptible to more
67
“When interpreting an integrated writing, the parol-evidence rule precludes considering evidence that would
render a contract ambiguous when the document, on its face, is capable of a definite legal meaning.” Americo Life,
440 S.W.3d at 22. “The rule does not, however, prohibit considering surrounding facts and circumstances that
inform the contract text and render it capable of only one meaning.” Id.
68
“[It is] well-established law that instruments pertaining to the same transaction may be read together to ascertain
the parties’ intent, even if the parties executed the instruments at different times and the instruments do not expressly
refer to each other, and that a court may determine, as a matter of law, that multiple documents comprise a written
contract.” Fort Worth Indep. School Dist. v. City of Fort Worth, 22 S.W.3d 831, 840 (Tex. 2000) (citing cases),
superseded by statute on other grounds, Martin v. Martin, 326 S.W.3d 741 (Tex. App. – Texarkana 2010, pet.
denied).
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than one meaning.” Id. “Whether a contract is ambiguous is a question of law for the court to
decide by looking at the contract as a whole in light of the circumstances present when the
contract was entered.” Id. An ambiguity does arise “simply because the parties disagree over its
meaning,” Kachina Pipeline, 2015 Tex. LEXIS 549 at *9 (quotations and citations omitted), or
“advance conflicting interpretations of the contact,” Columbia Gas Trans. Corp. v. New Ulm
Gas, 940 S.W.2d 587, 589 (Tex. 1996). Rather, both interpretations must be reasonable for an
ambiguity to exist. Id. In the event of an ambiguity, extrinsic evidence is admissible to give the
ambiguous terms “a meaning consistent with that to which they are reasonably susceptible, i.e.,
to ‘interpret’ contractual terms.” Nat’l Union Fire Ins. Co. of Pittsburgh, Penn. v. CBI Indus.,
Inc., 907 S.W.2d 517, 521 (Tex. 1994).
(b)
The Master Agreement Is Not Ambiguous; Nor Is The Integrated Lease.
55.
Section 15.23(b) of the Master Agreement, which the Lease is wholly integrated
into and controlled by,69 allows for an adjustment of the Base Rent upon the occurrence of a
force majeure event. As stated, § 15.23(b) provides:
If following the Closing Date there occurs material changes in an
applicable healthcare law or the interpretation thereof, including
without limitation, Medicare and Medicaid laws, regulations, and
instructions promulgated there under (including reimbursement
amounts or methodology), or government programs funding
indigent care and/or in the indigent population seeking care within
El Paso County, which materially increases the financial burden on
the DISTRICT or EPCH relative to its compliance with this
Agreement and the Related Agreements, taken as a whole, beyond
69
Sections 16.1 and 16.1.1 of the Master Agreement state, “The following Attachments attached hereto are
incorporated herein by reference as if fully set forth: . . . Attachment A – Facility Lease . . . .” See Ex. G, ¶ 16.1 &
16.1.1 (emphasis added). And the Chairman of the Debtor’s Board of Directors, Sam Legate, testified without
objection or contradiction about how the Lease was made part of the Master Agreement, and the Master Agreement
“was the overall agreement” between the parties. See Ex. B, Tr. 7/30 Hr’g, 95:25-96:18. The Master Agreement
and the Lease also bear the same effective dates, i.e., February 1, 2012. Compare [Ex. G, p. 1 with Ex. I, § 21]. The
Master Agreement even cross-references the Base Rent payment provision of the Lease. Ex. G, § 1.1 (defining
“Base Rent” as “the base rent payable under Article 1.5 of the Facility Lease Agreement”)]; see also Ex. I, § 1.5]
(identifying the Base Rent under the Lease). UMC’s attempt to invoke the Lease’s own merger and integration
clause does not alter this outcome, as the four-corners of the Lease extends to the Master Agreement.
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which is reasonably to be anticipated by an experienced operator of
health facilities as of the Closing Date, and which change is not
within the control of, and the effect of which cannot be avoided by,
such adversely affected party, then at the request of the adversely
affected party, the two parties hereto shall use their respective
reasonable efforts to negotiate in good faith to adopt
amendments to this Agreement and the Related Agreements,
including adjustments, if any, to the Rent due under the Lease, to
take such changes into account.70
It is without question that this provision requires UMC to negotiate in good faith to adjust the
Base Rent to take into account the force majeure events that uncontrollably increased the
Debtor’s financial burdens.
56.
It is also without question that such a force majeure event has occurred. In the
Forbearance Agreement, UMC even agreed as much per the following recital:
WHEREAS, significant changes in health care funding at the state
and federal level have impacted the projected revenue generation
and cash flow available to EPCH in its start up phase and as a
result EPCH is presently unable to make payments to the District
in full accordance within the terms of the Covered Agreements
[which include the Lease] . . . requires additional time to make
payments.71
And, in accordance with both § 13.6 of the Master Agreement and § 19.2 of the Lease, the
Debtor even gave UMC notice of the force majeure event and requested adjustment of the Base
Rent same within eighteen months after the Closing Date.72
Section 13.6 of the Master
Agreement and states:
The parties agree to review the terms of this Agreement within the
first [eighteen] (18) months of the Closing Date [or Lease
Commencement Date] to determine whether, under the actual
circumstances of the operation of the El Paso Children’s
Hospital, the Agreement is meeting the reasonable expectations
70
See Ex. G, ¶ 15.23(b) (emphasis added).
See Ex. E, p. 2.
72
See Ex. J, p. 3 (stating that Debtor “hereby gives notice to UMC of its request to negotiate in good faith
amendments to the Agreements, including appropriate adjustments to the rent and fees set forth in such
Agreements”) (emphasis added).
71
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that the parties had when they entered this Agreement. If either
party determines in good faith that the Agreement is not meeting
reasonable expectations, then either party may propose an
amendment to this Agreement, which the parties agree to
negotiate in good faith.73
Such is yet another obligation for UMC to negotiate an adjustment of the Base Rent in good
faith.
57.
For these reasons, it is without question that a force majeure event has occurred,
and that UMC is obligated to negotiate an adjustment of the Base Rent in good faith that both
takes into account the force majeure events that uncontrollably increased the Debtor’s financial
burdens (as per §15.23(b) of the Master Agreement) and meets the reasonable expectations that
the parties had when they entered into their agreement (as per § 13.6 of the Master Agreement
and § 19.2 of the Lease). The Base Rent was adjusted in fulfillment of those obligations under
the Master Agreement and Lease by way of the 2014 Amendment, which confirmed that the
Base Rent amounts for fiscal years 2014 and 2015 were/are zero (i.e., $0.00); however, UMC
refuses to comply with the 2014 Amendment opting instead to proceed with the Motion and
pressure the Debtor into submission.
(c)
Any Ambiguity In The 2014 Amendment Should Be Resolved In The
Debtor’s Favor.
58.
The required adjustment in the Base Rent was accomplished by the 2014
Amendment, wherein the parties unambiguously agreed that no “Cash Basis” for the Base Rent
was owed for fiscal years 2014 and 2015, i.e., the “red” fields in the spreadsheet attached to and
made a part of the Acknowledgement were left blank, which represents an amount of zero dollars
($0.00).74 UMC, however, attempts to interpret the 2014 Amendment as lacking any sort of
agreement as to the adjustment of the Base Rent, and attempts to argue that the 2014
73
74
See Ex. G, § 13.6 (emphasis added).
See Ex. H.
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Amendment did not amend the Lease.75 UMC’s interpretation of the 2014 Amendment is
unreasonable.
59.
But in the event UMC’s interpretation creates an ambiguity in the 2014
Amendment, then various extrinsic evidence supports the Debtor’s interpretation. This includes
the following examples, in addition to those set forth elsewhere herein:
•
The Debtor’s former CEO, Ray Dziesinski, who signed the 2014
Amendment on the Debtor’s behalf, unequivocally testified that
the “red” fields in the 2014 Amendment’s spreadsheet was
“intended to mean zero.”76 Such testimony is supported by the fact
that the “Total” amount due under the “Cash Basis” columns for
fiscal year 2014 and 2015 add up to amounts that would consider
the “red” fields to be zero,77 and such amounts “were intended to
represent the definitive commentary on this particular issue.”78
•
The parties had always intended to reform the Base Rent provision
of the Lease, as per the pre-signing conversations between the
Chairman of the Debtor’s Board of Directors, Sam Legate, and
UMC’s CEO, Jim Valenti, wherein Mr. Valenti said that there
would later be adjustments to rent under the Lease, and that Mr.
Legate should “just trust [him].”79
•
UMC cannot offer any explanation that justifies the Base Rent
being an amount in excess of zero (i.e., $0.00). In his 2004
examination, Mr. DeGroat testified as follows about the Lease:
75
UMC cites to the July 30, 2015 hearing testimony of the Debtor’s former CEO, Ray Dziesnski, and Chairman of
the Debtor’s Board of Directors, Sam Legate, that the Lease was never “modifi[ed],” “reworked,” or otherwise
amended in an attempt to discredit the notion that the 2014 Amendment was not an agreement to adjust the Base
Rent. See Dckt. #227 at ¶¶ 31, 34 (Motion). But UMC fails to realize the nuance. The Debtor believes that a
number of the Lease’s provisions would have to be modified, reworked, or otherwise amended. See, e.g., Ex. B Tr.
7/30 Hr’g, 131:24-132:5 (Legate testimony) (“Q. But at the time when these documents were executed and the
board approved them, I assume, you know, you believed it was in the best interest in your business judgment of the
Children’s Hospital to enter into these agreements. A. Yes, with the understanding that they would be reworked at
a future date.”). The 2014 Amendment, however, did not modify, rework, or otherwise amend the Lease. Instead, it
fulfilled the existing and express obligations of Sections 15.23(b) and 13.6 of the Master Agreement and Section
19.2 of the Lease to adjust the Base Rent under stated circumstances that did in fact occur. Thus, the testimony of
Messrs. Dziesnski and Legate are consistent with the Debtor’s position.
76
Ex. B, Tr. 7/30 Hr’g, 44:6-45:5, 46:14-47:15.
77
Ex. H, p. 2.
78
Ex. B, Tr. 7/30 Hr’g, 44:6-46:11.
79
See Ex. B, Tr. 7/30 Hr’g, 134:5-136:6. (“But there were conversations about that the lease had to be there, ‘Just
trust me.’ That would be Mr. Valente’s words, ‘Just trust me.’”).
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•
•
Q.
But generally it’s your understanding that the triple net
obligations under the facility lease are in addition to the
$860,000 a month that’s owed?
A.
Yes.
Q.
How much of the $860,000 a month do you believe is
attributable to depreciation?
A.
The majority of it.80
Mr. DeGroat went on to further testify that “UMC is entitled to a
lease payment that equals fair market value as determined by
third-party experts.”81 Mr. DeGroat testified that the rent charged
under the Lease was “primarily for depreciation,” and further
testified as follows:
Q.
How does depreciation relate to fair market value?
A.
I have no idea.82
UMC lacks credibility on the matter. The testimony of its CEO, Jim Valenti,
given at the recent August 31, 2015 hearing before the Court, establishes that
UMC that it has taken, and continues to take, a ludicrous and contradictory
position to the entire matter. Mr. Valenti testified to the following:
Q.
Mr. Valenti, you testified that there were many efforts
between the Children’s Hospital and UMC to negotiate a
settlement of their various differences; isn’t that right?
A.
Absolutely.
Q.
But with respect to the rent due under the lease, that was
never adjusted by UMC, was it?
A.
It was never adjusted.
Q.
In fact, it’s your recollection, Mr. Valenti, that the
Children’s Hospital management and the Children’s
Hospital board never requested that the rent be adjusted;
isn’t that right?
A.
That’s the testimony I gave.83
80
Ex. F, Tr. 55:7-13.
Ex. F, Tr. 57:1-3.
82
Ex. F, Tr. 58-25:59-2.
81
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Mr. Valenti provided this testimony despite his own admission that UMC wanted to see the
Debtor succeed, that the only driver for UMC’s decision to charge the Debtor over $10 million a
year in rent was “[f]rom a fair market perspective,”84 and that there were many efforts between
the parties to negotiate the settlement of their various differences,85 and despite the fact that such
negotiations did in fact include the issue of Base Rent.86
Accordingly, the evidence demontrates that the 2014 Amendment does not require the
Debtor to pay the Base Rent under the Lease; and, therefore, the Debtor should not be compelled
to pay any such amounts. The Court should deny the Motion.
H.
The Court Should Deny the Motion as a Matter of Equity Because The Harm to the
Debtor and the El Paso Community Should the Court Grant the Motion Greatly
Outweighs the Harm to UMC Should the Court Deny the Motion.
60.
The Court has the “equitable power and duty to sift the circumstances surrounding
any claim to see that injustice or unfairness is not done in administration of the bankruptcy
estate.” See 11 U.S.C. § 105(a) (“The court may issue any order . . . that is necessary or
appropriate to carry out the provisions of this title.”); see F.D.I.C. v. Jones (In re Jones), 966
F.2d 169, 173 (5th Cir. 1992) (discussing § 105(a) and the court’s power and duty to avoid
injustice and unfairness). It should exercise that power, and avoid the unjust and unfair relief
that UMC requests, by denying the Motion.
61.
Trial is set for October 22, 2015, less than two months from the date hereof, Dckt.
#22 at ¶ 10 (Scheduling Order), at which time the parties will try the issue of whether any Base
Rent is owed under the Lease. If the Court denies the Motion, then the only potential harm to
83
Ex. A, Tr. 8/11 Hr’g, 224:5-224:16 (emphasis added).
But, again, UMC “has no idea” of how depreciation relates to fair market value under the Lease. See Ex. F, Tr.
58-25:59-2 (DeGroat testimony).
85
Ex. A, Tr. 8/11 Hr’g, 224:5-224:16
86
See Ex. G, p. 3.
84
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UMC is the potential loss of money.87 UMC should be able to survive the interim period
between now and the conclusion of trial without such payments given its own allegations of
financial stability (e.g., the allegation under its proposed plan for reorganization that UMC is
willing and able to subordinate its claims to those of other creditors for some time).88
62.
In contrast, if the Court grants the Motion, then the potential injury to the Debtor
and the El Paso community would be horrendous and irreversible. The Debtor will be left
unable to operate independent of UMC. And under the operation and control of UMC, the high
quality of the medical facilities and services provided by the Debtor to the children and indigent
of El Paso will greatly diminish and, eventually, disappear.89 The Court should avoid such
injustice and unfairness by denying the Motion.
IV. CONCLUSION
63.
Given the circumstances surrounding the Lease, the Debtor should not be
compelled to pay amounts attributable to rent under the Lease, and the Motion should be denied.
Compliance with the disputed Lease, particularly when UMC itself as acknowledged no rent
would be paid this year, should not be required, in the face of the mountain of evidence already
before the Court, that the Lease is not a true lease. Section 365 of the Bankruptcy Code does not
apply to the Lease because it is not a true lease, and the economic realities of the Lease illustrate
that § 365 should not apply in this proceeding. Moreover, the law does not require the Debtor to
87
See Motion (UMC’s Motion only seeks to compel the payment of money).
See UMC Termination Motion, ¶¶ 9-10 (alleging that UMC’s proposed reorganization plan would, among other
things, “provide complete or substantial payment to Texas Tech and the Debtor’s other creditors through UMC’s
voluntary debt subordination”).
89
See Debtor’s Exclusivity Motion [Dckt. No. 165], ¶¶ 8-14, which are incorporated herein by reference (explaining
how “UMC displays sustained and systemic operational issues and an inability to correct those issues that are
incompatible with the Debtor’s mission,” such as UMC’s receipt of “the worst” score for “total hospital acquired
condition . . . according to the CMS database”)
88
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pay any amounts to UMC which are not owed in the first place; and it would be unjust and unfair
as a matter of equity for the Court to compel such payments. The Motion should be denied.
WHEREFORE, PREMISES CONSIDERED the Debtor respectfully requests that the
Court deny the Motion to Compel Payment of Facility Lease filed by UMC, and grant to it such
other and further relief to which it may be justly entitled.
Dated: August 26, 2015.
Respectfully submitted,
JACKSON WALKER L.L.P.
100 Congress Ave., Suite 1100
Austin, Texas 78701
(512) 236-2000
(512) 236-2002 - FAX
By: /s/ Patricia B. Tomasco
Patricia B. Tomasco
State Bar No. 01797600
(512) 236-2076 – Direct Phone
(512) 691-4438 – Direct Fax
Email address: [email protected]
Marvin E. Sprouse III
State Bar No. 24008067
(512) 236-2088 – Direct Phone
(512) 391-2148 – Direct Fax
Email address: [email protected]
Jennifer F. Wertz
State Bar No. 24072822
(512) 236-2247 – Direct Phone
(512) 391-2147 – Direct Fax
Email address: [email protected]
COUNSEL FOR DEBTOR-INPOSSESSION
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CERTIFICATE OF SERVICE
I hereby certify that on the 26th day of August 2015, a true and correct copy of the
foregoing was served via the Court’s CM/ECF electronic notification system on all parties
requesting same.
UNITED STATES TRUSTEE
Kevin Epstein, Trial Attorney
615 E Houston Street, Room 533
San Antonio, Texas 78205
/s/ Patricia B. Tomasco
Patricia B. Tomasco
14533552v.3 145048/00008
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