IN THE UNITED STATES BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION IN RE: MERVYNS HOLDINGS,

LLC, et al., Debtors. ) ) ) ) ) ) ) ) Chapter 11 Case No. 08-11586(KG) Jointly Administered Hearing Date: Jan. 21, 2009 at 9:30 am Relates To: Docket Nos. 998 and 1084

THE PALM DUNDEE PARTIES AND THE LAGUNA DUNDEE PARTIES REPLY BRIEF IN SUPPORT OF THEIR MOTION FOR RULING ON THEIR LIMITED OBJECTION TO THE DEBTORS NOTICE OF REJECTION OF UNEXPIRED LEASES AND TO COMPEL DEBTORS TO PAY DECEMBER 2008 RENT In support of their Motion for Ruling on Their Limited Objection to the Debtors Notice of Rejection of Unexpired Leases and to Compel Debtors to Pay December 2008 Rent (the December Rent Motion) [Docket No. 1084], and in reply to the Objection of Debtors and Debtors in Possession to the Palm Dundee Parties and the Laguna Dundee Parties Motion for Ruling on their Limited Objection to the Debtors Notice of Rejection of Unexpired Leases and to Compel Debtors to Pay December 2008 Rent (the Debtors December Rent Motion Response) [Docket No. 1834], the Palm Dundee Parties and the Laguna Dundee Parties (collectively referred to as the Objecting Landlords) state as follows: I. 1. Introduction The Debtors ask this Court to circumvent Bankruptcy Code Section 365(d)(3) and

the clear, controlling case law that obligates them to pay December 2008 rent in full to the Objecting Landlords and instead apply equitable principles under Section 105(a) of the Bankruptcy Code to deny the Objecting Landlords the rent to which they are entitled. But 105(a) and equitable principles are irrelevant in light of Montgomery Wards holding that

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365(d)(3) requires a trustee (or debtor-in-possession) to fully perform lease obligations (like the obligation to pay rent in this instance) as those obligations arise. Simply put, this Court cannot even consider the so-called equitable arguments raised in Debtors brief. But even if these arguments could be considered, there is nothing inequitable about enforcing a debtors postpetition agreements with its landlord. Furthermore, as the Sixth Circuit stated in Koenig, there is nothing inequitable about strictly enforcing notice requirements contained in lease rejection procedures against a debtor (who proposed the very procedures it seeks to evade) when the debtor alone was in the position to control when rejection notices were sent1. Regardless of whether the effective date of rejection is December 1 or 2, 2008, the Objecting Landlords are entitled to the full December 2008 rent under the Palm Desert and Laguna Niguel Leases. II. 2. Argument Although the Debtors use over-inflated rhetoric throughout their brief (which

would be unnecessary if they were asserting a valid legal position), the Debtors December Rent Motion Response boils down to the following three essential arguments: (1) Montgomery Ward is not controlling here because that case dealt with real estate taxes due under a lease and not rent and because equitable considerations are more important than Montgomery Ward; (2) the Debtors provided sufficient notice of rejection to cut off the Objecting Landlords right to December 2008 rent (which includes the subarguments that (a) Debtors were only required to serve notice on one of the four representatives for the Objecting Landlords identified in the parties side letter agreement and (b) regardless of the parties side letter agreement, if notice was
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Of course, it is likely that the Debtors relied upon their bankruptcy attorneys to provide timely rejection notices. If that is the case, the most equitable resolution of this dispute would be to deduct the

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given on the day it was sent rather than received, the effective date of rejection is December 1, 2008 and no December 2008 rent is owed); and (3) December 2008 rent is not due because the leases contain what the Debtors refer to as a 10-day grace period. Each of these arguments is simply wrong. A. Under Montgomery Ward and Koenig, The Debtors Are Required To Pay December 2008 Rent Because They Failed To Reject The Leases at Issue On Or Before November 30, 2008.

The Debtors make two seriously misguided arguments on page 8 of their brief. First, they argue that the holding in In re Montgomery Ward Holding Corp., 268 F.3d 205 (3rd Cir. 2001) does not control the resolution of the December Rent Motion because that opinion dealt with statutory real estate taxes and not rent under a lease. Second, Debtors argue that equitable considerations are more important to the question of the Debtors liability for December 2008 rent than an analysis of the Third Circuits holding in Montgomery Ward and the Courts interpretation of Bankruptcy Code 365(d)(3). Contrary to the Debtors arguments,

Montgomery Ward demonstrates that the Debtors are obligated to pay December 2008 rent in full and precludes this Court from even entertaining the Debtors equitable arguments. (1) The Montgomery Ward Opinion Controls The Resolution of The December Rent Motion.

The Debtors do not contest that Article 2.01 of both leases (see Exhibits 1 and 2 to the December Rent Motion) states that rent is payable in equal monthly installments on the first (1st) day of the Term and on the first (1st) day of each calendar month thereafter of the Term

cost the Debtors will incur to pay December 2008 rent from Debtors counsels next fee petition and deny Debtors counsel any fees in connection its response to the December Rent Motion.

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As a result, if the leases were not rejected by November 30, 2008, December 2008 rent is owed in full. 11 U.S.C. 365(d)(3) states that the trustee shall timely perform all of the obligations of the debtorarising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected. In the very first

paragraph of the Montgomery Ward opinion, the Third Circuit states unequivocally that Section 365 of Title 11 requires that a bankruptcy trustee fulfill all the obligations that arise under a nonresidential lease subsequent to the entry of the bankruptcy order and prior to the time that the lease is rejected. Montgomery Ward, 268 F.3d at 206 (emphasis added). Contrary to the Debtors argument that a debtor-lessees obligation under a lease to pay real estate taxes is somehow different from a debtor-lessees obligation to pay rent, the Montgomery Ward court specifically said that [t]ax reimbursement obligations are only a small constellation in the universe of obligations coming within the scope of 365(d)(3), and there is no basis in the text for distinguishing them from rent and numerous other obligations of tenants. Id. at 212. Furthermore, the Third Circuit relied upon the Sixth Circuits opinion in In re Koenig Sporting Goods, Inc., 203 F.3d 986 (6th Cir. 2000), a case which held that a debtor-tenant had to pay December rent in full because it failed to reject its lease effective November 30. In fact, the Debtors argument is even more radical that the proration approach the Montgomery Ward court rejected as being flatly inconsistent with the plain language of 365(d)(3). Under the proration approach, if the effective date of lease rejection for the Palm Desert Lease and the Laguna Niguel Lease is December 1, 2008, as the Debtors argue, the Debtors would at least be responsible for one-days worth of rent. Here, the Debtors argue that

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the effective date of rejection is December 1, 2008 (which, as is explained below, is incorrect) but that they have no obligation to pay any rent for December 2008. They cite no legal support for this argument. The Debtors fail to even cite Koenig (relied upon in the December Rent Motion and in Montgomery Ward), undoubtedly because that opinion rejects the arguments raised by the Debtors under nearly identical facts. In that case, Koenig Sporting Goods (the debtor or

Koenig) entered into a lease with Morse (the landlord) which required Koenig to pay rent on the first day of each month. Koenig, 203 F.3 at 987. Koenig filed a Chapter 11 petition, sought leave to conduct going out of business sales at the property owned by Morse and its other stores and, like the Debtors here, sought an extension of time within which to assume and assign or reject leases. Id. at 988. Koenig also sought the right to reject leases on seven-days notice. Id. On November 25, 1997, Koenig provided Morse with a notice rejecting its lease which, under the procedures requested by the debtor, meant that the effective date of rejection was December 2, 2008. Id. The debtor claimed that it only owed two days worth of rent for December, so Morse sought a bankruptcy court order requiring Koenig to pay rent for the full month of December. Id. After noting that a debtors obligations under 365(d)(3) are distinct from the principles governing administrative expenses under 503(b)(1) (even the Debtors here admit that), the Sixth Circuit held that, because the lease required the payment of a full months rent on the first day of each month, Koenig was required to pay December rent in full. Id. at 989. The court stated that if the debtor, who alone was in the position to control Morse entitlement to payment of rent for Decemberhad rejected the lease effective November 30, 1997, rather than

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December 2, it would not have been obligated to pay rent for December under 11 U.S.C. 365(d)(3). Id. The Seventh Circuit reached the exact same conclusion in HA-LO Industries, Inc. v. Centerpoint Properties Trust, 342 F.2d 794, 800 (7th Cir. 2003), where it stated that if HA-LO had rejected the lease effective October 31, rather than November 2, it would not have been obligated to pay rent for November under 11 U.S.C. 365(d)(3). The same is true here. If the Debtors had wanted to avoid the payment of December 2008 rent, they should have provided sufficient notice (under the procedures they themselves sought from this Court) to make sure the effective date of rejection for the Palm Desert and Laguna Niguel Leases was November 30, 2008 or earlier. (2) This Court Does Not Have The Authority To Consider The Equitable Arguments Asserted By The Debtors.

The Debtors start their second argument off by saying that [m]ore importantly, this Court should deny the December Rent motion under general equitable arguments rather than 365(d)(3) and Montgomery Ward. But under long-established law, wherever the rights or the situation of the parties are clearly defined and established by law, equity has no power to change or unsettle those rights or that situation. Magniac v. Thomson, 56 U.S. 281, 299 (1853). This Court does not have the authority to even consider the so-called equitable arguments raised by the Debtors. In Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988), the U.S. Supreme Court stated that whatever equitable powers remain in the bankruptcy courts must and can only be used within the confines of the Bankruptcy Code. Equitable principles are not a license to courts to invent remedies that overstep statutory limitations, In re Joint Eastern and Southern District Asbestos Litigation, 982 F.2d 721, 751 (2nd Cir. 1992) because, as stated in In re Fesco -6-

Plastics Corp., 996 F.2d 152, 154 (7th Cir. 1993), when a specific Code section addresses an issue, a court may not employ its equitable powers to achieve a result not contemplated by the Code. The Debtors assumption that this Court has the authority to use 105(a) of the Code to change the application of 365(d)(3), as that provision has been interpreted by the Third Circuit, is fundamentally wrong. Section 105(a) does not give the court the power to create substantive rights that would otherwise be unavailable under the Code and it does not empower courts to expand the contractual obligations of the parties[because] section 105(a) is not a substantive source of rights. In re Morristown & Erie Railroad Co., 885 F.2d 98, 100 (3rd Cir. 1989); see also United States v. Pepperman, 976 F.2d 123, 131 (3rd Cir. 1992). If controlling case law answers a question regarding a debtors legal entitlements, the bankruptcy court may do nothing more than apply the controlling opinion, because equitable concerns or extraneous factors not contemplated by the case may not be imported into the courts analysis. In re Faish, 72 F.3d 298, 306 (3rd Cir. 1995). Section 105(a) does not permit bankruptcy courts to authorize relief inconsistent with specific Code provisions. In re Combustion Engineering, 391 F.3d 190, 236 (3rd Cir. 2005) (the general powers of 105(a) cannot be used to achieve a result not contemplated by the more specific provision of 524(g)); In re Lowenschuss, 67 F.3d 1394, 1402 (9th Cir. 1995) (same). In Montgomery Ward, the Third Circuit stated that, even if there are policy arguments that support the application of the proration approach to 365(d)(3), the language of 365(d)(2) requires a debtor to pay lease obligations in full as those obligations arise and it is not our roleto make better laws than those fashioned by Congress. Montgomery Ward, 268

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F.3d at 211. In a later district court opinion in the Montgomery Ward bankruptcy, the district court stated that because the Third Circuit has held that the billing date approach should apply as a matter of strict statutory construction, decisions regarding whether a lease obligation must be paid may not be determined by equitable arguments but must, instead, be decided under the Third Circuits opinion in Montgomery Ward. In re Montgomery Ward, 302 B.R. 478, 482 (D. Del. 2003). Even if the equitable arguments raised by the Debtors had persuasive force (as the Koenig court stated, the Debtors have no one but themselves to blame for not rejecting the leases at issue here sooner), the arguments can not be considered. Ironically, the Debtors even admit in paragraph 20 of the Debtors December Rent Motion Response that, unlike administrative expense claims under 503(b)(1)(A), where the administrative claimant is required to show a substantial benefit to the Debtors estate, Section 365 of the Bankruptcy Code does not require a showing that the Debtors actually or substantially benefited from the transaction. See Valley Media, 290 B.R. at 76-77; In re Burival, 392 B.R. 793, 798 (Bankr. D. Neb. 2008) (Section 365(d)(3) specifically excludes consideration of 503(b)(1), however, so for purposes of this decision, benefit to the estate is immaterial.) But as soon as the Debtors state this valid legal premise, they argue that this Court should consider that the Debtors allegedly received no benefit from the premises in December. Once again, the Debtors have not and cannot provide any basis to support its argument that this Court should ignore clear statutory rules based on general notions of fairness. As stated in In re Jamo, 283 F.3d 392, 403 (1st Cir. 2002), Section 105(a) does not provide bankruptcy courts with a roving writ.

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In re Kaiser Aluminum Corp., 456 F.3d 328 (3rd Cir. 2006), which the Debtors rely upon, also provides that a Bankruptcy Court has no authority to apply equitable principles that contravene a clear mandate from Congress. Kaiser, 456 F.3d at 341. Because the Montgomery Ward Court ruled that 365(d)(3) is unambiguous and must be applied according to its terms without considerations of legislative history or the application of policy considerations, Montgomery Ward, 268 F.3d at 209-11, the Debtors equitable arguments should not even be considered. Even if this Court did have the authority to consider the Debtors so-called equitable arguments, these arguments are not persuasive. As the court in Koenig stated, where the debtor had complete control over the obligation to provide a timely notice of termination, we believe equity as well as the statute favors full payment of rent for any month during which a notice of rejection is provided. Koenig, 203 F.3d at 789; see also HA-LO Industries, 342 F.3d at 800 (same). In enacting 365(d)(3), Congress intended to protect landlords by requiring debtors to timely perform their obligations arising under the lease, In re Valley Media, Inc., 290 B.R. 73, 74 (Bankr. D. Del. 2003) and it also sought to protect landlords by shifting the burden of the debtors indecision from the landlord to the debtor. In re Pac-West Telecomm, Inc., 377 B.R. 119, 125 (Bankr. D. Del. 2007). Requiring a debtor to pay monthly obligations as they become due creates a bright-line test that can be applied easily, leading to the efficient administration of bankruptcy proceedings. Furthermore, this is not the only instance in which a participant in a bankruptcy proceeding is expected to pay attention to and comply with deadlines.

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Here, the Objecting Landlords are simply enforcing an agreement into which the Debtors themselves agreed to enter2. B. Although The Effective Date Of Rejection Is December 2, 2008 Under The Facts And The Parties Side Letter Agreement, The Debtors Must Pay December 2008 Rent Even If The Effective Date Of Rejection Is December 1, 2008.

The Debtors raise a number of arguments regarding notice in order to assert that the effective date of rejection for the two leases at issue here is December 1, 2008, rather than December 2, 2008, and that this distinction makes a difference. The Debtors arguments are misguided. The effective date of rejection is December 2, 2008 under the undisputed facts and the parties court-approved side letter agreement. But even if the effective date of rejection were December 1, 2008, it would make no difference. The Debtors are still be obligated to pay December 2008 rent in full because they failed to reject the leases at issue here effective November 30, 2008. The essential elements of the parties side letter agreement are that (1) the Objecting Landlords would have 10 days from the actual receipt of the notice of rejection to object to the Debtors attempt to reject their leases; (2) if no objection to rejection is raised, the effective date of rejection would be 11 days following receipt of notice and (3) notice would be sent to Michael Braude, Jack Carriglio, Eric Newman and Dennis Fields.

The Debtors floodgate argument, asserted in paragraph 21 of their brief, requires little attention. The Debtors have now rejected or assumed and assigned most, if not all, of their store leases, and the time periods for filing objections to the rejection notices have expired. The Objecting Landlords are not aware of any other dispute between the Debtors and a landlord regarding the effective date of rejection for a lease.

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The Debtors argue, first, that the effective date of rejection is December 1, 2008 because they were only obligated to serve one out of the four landlord representatives listed in the parties side letter agreement. This argument is wrong. As it can be seen in the parties email exchange memorializing their side letter agreement (another copy of this exchange is attached hereto as Exhibit A), it was agreed that notice would be sent to the following addresses (plural) and the addresses for Michael Braude, Jack Carriglio, Eric Newman and Dennis Fields are all listed. There can be no doubt that the Debtors agreed to effectuate service on all four of these individuals and, in fact, notice was served on all four. It was also agreed that notice would be deemed effective on the date it was received by each of these individuals. There is no dispute that Dennis Fields received his notice of rejection on November 21, 2008. The effective date of rejection is December 2, 2008. But it is also clear that the Debtors did not serve any of the four individuals upon whom they agreed to provide notice before November 20, 2008. As a result, even under the Debtors argument, the effective date of rejection could not be any earlier than December 1, 2008. Since the leases at issue were not rejected before December 1, 2008, when the obligation to pay rent arose, the Debtors are responsible for December 2008 rent. Second, Debtors argue on page 8 of their response brief that KCC served the notices which service was effective upon all four parties on November 20, 2008. Since Kurtzman Carson Consultants (KCC) gave the notice of rejection addressed to Dennis Fields to Federal Express on November 20, 2008, the Debtors argue that all four of the persons to whom they were obligated to give notice were served on November 20, 2008 and that the effective date is December 1, 2008. But the side letter agreement provides that the effective date of rejection

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shall be the 11th day following receipt of the notice (emphasis supplied). The notice was delivered to Mr. Fields on November 21, 2008. Applying the parties agreement, the effective date of rejection is December 2, 2008. Under Morristown & Erie Railroad, 885 F.2d at 100, this Court may not use 105(a) of the Code to modify the clear terms of the parties agreement by shortening the notice periods to which the Debtors agreed. While it is clear that the effective date of rejection is December 2, 2008, in the end, it does not make any difference whether the effective date of rejection is December 1, 2008 or December 2, 2008. In either event, the lease was not rejected until December 2008 and, by that time, the Debtors owed the Objecting Landlords December 2008 rent. As the Koenig court stated, if the Debtors had wanted to avoid December rent, they should have caused the lease to be rejected as of November 30, 2008. Koenig, 203 F.3d at 989; see also HA-LO Industries, 342 F.3d at 800 (same) C. What The Debtors Refer to As A Ten Day Grace Period Is A Default Provision That Has No Effect On The Debtors Obligation To Pay December 2008 Rent.

In a footnote, the Debtors half-heartedly assert that they should not be required to pay December 2008 rent because the two leases at issue have a 10 day grace period for the payment of rent. This argument is so misguided the Debtors didnt even bother to cite the section of the leases to which they are referring. Article 16.01 of both leases define an event of default as the [f]ailure by Tenant to pay any Rent within ten (10) days after written notice of failure to pay the same on the due date. But as the Third Circuit made clear, a trustee or debtor-in-possession is required to perform [lease] obligations as they become due. Montgomery Ward, 268 F.3d at 209 (emphasis added).

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The Court did not say a debtor-tenant is required to perform lease obligations only after the tenants failure to pay creates a default under the lease. The two leases at issue here clearly state that rent is due on the first day of the month. The Debtors owe December 2008 rent and this Court should compel them to pay it. WHEREFORE, Palm Dundee One LLC, Palm Dundee Two LLC and Palm Dundee Three LLC and Laguna Dundee One LLC and Laguna Dundee Two LLC respectfully request that an order be entered (1) declaring that the effective date of rejection for the Palm Desert Lease and the Laguna Niguel Lease is December 2, 2008 and (2) ordering the Debtors to immediately pay the Palm Dundee Parties $108,865.98 and the Laguna Dundee Parties $152,056.35.

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Date: January 16, 2008 Respectfully Submitted, PRICKETT JONES AND ELLIOT, P.A.

By:

/s/ Bruce E. Jameson Bruce E. Jameson (DE Bar No. 2931)

Prickett Jones & Elliott, P.A. 1310 King Street PO Box 1328 Wilmington, DE 19801 Telephone: 302-888-6500 Facsimile: 302-658-8111 E-Mail: bejameson@prickett.com

MECKLER BULGER TILSON MARICK & PEARSON LLP

Jack J. Carriglio Eric E. Newman 123 N. Wacker Drive, Suite 1800 Chicago, IL 60606 Telephone: 312-474-7900 Facsimile: 312-474-7898 E-Mail: jack.carriglio@mbtlaw.com eric.newman@mbtlaw.com Attorneys for the Palm Dundee Parties and

the Laguna Dundee Parties

M:\12891\pleading\december-rent\compel-dec-rent-reply.doc

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EXHIBIT A: PALM DUNDEE AND LAGUNA DUNDEE REPLY BRIEF: COMPEL DECEMBER RENT