Some of our readers may have had the pleasure of renting a resort villa during their summer vacation (electronic postcards of such fancy digs are always welcome at the Weil Bankruptcy Blog, especially if you pose for a photo where you are reading one of our entries!). For the uninitiated (including yours truly), villas are often viewed as the ultimate upgrade for privacy and convenience when staying at a large resort for a week or more—a private home with the luxuries of a full service hotel. A villa is not exactly the first thing that comes to mind when thinking of real estate bankruptcies, but the recent decision by Judge Lane of the United States Bankruptcy Court for the Southern District of New York in the chapter 11 cases of In re MSR Resort Golf Course LLC gives a glimpse into the business behind these luxury rentals.

The decision arises out of cross motions for summary judgment in a cure assumption dispute. Specifically, the debtor, which owned and operated an Arizona hotel resort, had sold substantially all of its assets to a third party during its bankruptcy. In connection with that sale, the debtor assumed and assigned to the purchaser certain revenue sharing agreements between it and certain villa condominium owners, whose condos were used by the debtor as available rooms for rental to its guests in exchange for a fifty-fifty split of profits earned. One of the villa owners asserted that the debtor owed it cure amounts in excess of what had been paid at the time of assumption. It argued that the debtor owed it (i) its half of additional revenue earned on account of incremental guest charges (such as room fees, no-show cancellation charges, telephone charges, and golf course “green fees”) that were not included in the debtor’s original base profit sharing calculation, and (ii) additional revenue for failure to adhere to an alleged practice of paying villa owners approximately 17% of the total room revenues generated by the hotel and the villas. The debtor asserted that the claims had been previously litigated and resolved in two separate prepetition lawsuits before an Arizona federal district court, but the creditor disputed the applicability of those decisions to its objection, asserting that the claims for which it was seeking compensation fell outside the ambit of those decisions.

The bankruptcy court found almost entirely in favor of the debtor. Applying Arizona law, it determined that the creditor’s claims for its portion of the incremental guest charges was barred by the doctrine of res judicata, which, simply put, prevents relitigation of the same claims between the same parties where those claims were reduced to final judgment in a previous litigation. Because the court found that the creditor had received compensation in settlement of its claims in the prior lawsuits and was not alleging any change in the debtor’s practice since, it concluded that the creditor could not assert additional damages for the same cause of action. Any other rule, the court determined, would “bless a strategy whereby a litigant [could] bring a new challenge every year based on the same contract even though none of the facts have changed.”

As to the creditor’s claim that the debtor owed it additional cure amounts on account of its historic practice of providing villa owners with 17% of total room revenues earned, the court found that the majority of the creditor’s claims were barred by the doctrine of collateral estoppel. Collateral estoppel prevents parties from relitigating issues regardless of whether a prior action is based upon the same claim as the second suit. In the prior litigation, the creditor had challenged the debtor’s 17% benchmark as arbitrary and inadequate, but the Arizona court did not agree, particularly where there was no contractual right, or other external evidence, supporting this additional right of payment for the villa owners. Thus, the bankruptcy court concluded that the creditor could not relitigate the issue of what the appropriate benchmark, if any, should be. It did, however, find that the previous litigation did not touch upon whether the debtor could pay less than the 17% benchmark (likely because the debtor had never paid less). Therefore, although expressing its doubt as to the merits of such a claim, the court found that this single issue—cure amounts arising from damages sustained for payments of less than 17%—was not barred by collateral estoppel and could be preserved for trial.

So, next time you are at a resort and look longingly at a villa, wishing, perhaps, that you might own one, think about the business behind the beauty. It’s not always as simple as it seems, and sometimes the owner may find itself “vacationing” in the bankruptcy courts!