Summary

In a 22 page decision released April 20, 2015, Judge Carey of the Delaware Bankruptcy Court provided guidance as to the calculation of lease rejection damages.  Judge Carey’s opinion is available here (the “Opinion”).  The interpretation of 11 U.S.C. Section 502(b)(6) differs depending on the court which is addressing the issue.  This is an issue that the Third Circuit has not ruled on and, as far as I am aware, the first time the Delaware Bankruptcy Court has published an opinion directly addressing the issue.  The dispute: The statute caps a landlord’s rent claim at “the greater of one year, or 15 percent.”  So, what is the 15% referring to: The total amount of payment due under the lease, or 15% of the remaining lease period?  Because many leases include increasing rent payments, the total amount due calculation will typically be larger than the amount due over the next 15% of the lease term.  The quick answer of Judge Carey’s Opinion?  15% refers to the time remaining, not the amount remaining.

Background

Filene’s Basement (the “Debtor”) had, like countless debtors before, rejected a lease through the bankruptcy process.  In this instance the landlord decided that rather than settling, like most litigants do, this landlord fought the good fight and held out until the Court issued its order.

The Debtor had also failed to satisfy a mechanic’s lien and left a significant of abandoned furniture and fixtures that the landlord had to remove.  The landlord sought to have the expense of both of these issues excluded from the 502(b)(6) cap, thereby increasing its claim for the full value of the mechanic’s lien and the removal costs.  Naturally, the Debtor requested the Court to cap the entirety of the landlord’s claim at the amount calculated under 502(b)(6).

Judge Carey’s Opinion

Judge Carey reviewed briefly the split of decisions as well as discussing the principles governing the interpretation of statutes.  In this discussion, his analysis of ambiguity deserves particular attention.  Judge Carey opines that “just because a particular provision may be, by itself, susceptible to differing constructions does not mean that the provision is therefore ambiguous.”  Opinion at *8.  Judge Carey quotes the Third Circuit’s opinion in Price v. Delaware State Police Federal Credit Union (In re Price), which provides that “a provision is ambiguous when, despite a studied examination of the statutory context, the natural reading of a provision remains elusive.”  370 F.3d 362, 369 (3d Cir. 2004)

Judge Carey then recites 502(b)(6), which provides: “the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease . . .”  He determines that 15%, not to exceed three years, unmistakably means that “15%” is a measure of time.  Opinion at *9.  Indeed, it would be strange to rephrase this provision as the landlord implicitly does here: $2.6 million (15%), not to exceed three years.

Judge Carey then analyzes the additional parts of the landlord’s claim, determining that any parts of the claim that “result[] from the termination of the Lease” will be included in the cap.  Opinion at *19.  Ultimately, Judge Carey holds that a mechanic’s lien results from a failure to pay another entity and not from the rejection, whereas the abandoned equipment does result from the rejection.  Thus, the mechanic’s lien was added to the claim and the cleanup of the abandoned equipment is included in the cap.  He places weight on the language of 502(b)(6) which caps claims arising from the “termination” of the lease and not just the “rejection” of the lease.  Opinion at *20.  Naturally, if the lease was not terminated, the landlord would have to obligation to remove the abandoned material.  However, even if the lease was not terminated, the landlord could be liable for the mechanic’s lien.

As with all matters brought before the Delaware Bankruptcy Court, you want to cite controlling precedent if possible.  In this instance, there was no controlling precedent on the interpretation of 502(b)(6)’s “15%” language, which means that a litigant is entering one of an attorney’s most distasteful situations, an unpredictable situation.

As the economy fluctuates, tenant bankruptcies become a greater risk for commercial landlords. Yet some landlords are not familiar with the rights provided to them under the Bankruptcy Code, nor are they aware of the protections provided to a tenant in bankruptcy. For example, certain lease provisions are unenforceable once a tenant files for bankruptcy. Should a landlord attempt to exercise its rights under the lease without first seeking approval from the bankruptcy court, the landlord may be subject to strong sanctions. The purpose of this article is to provide landlords with the questions and answers they should consider when a commercial tenant files for bankruptcy.

1. What effect does a tenant’s bankruptcy have on the lease?

Once a tenant files for bankruptcy, it has three options regarding the lease: it can assume the lease and continue performing all obligations, or assume and assign the lease to a third party, or reject the lease and surrender the premises and terminate performance. The Bankruptcy Code gives the debtor-tenant 120 days to decide whether to assume or reject the lease. During this period, the tenant can request one 90 day extension to decide what to do with the lease.

If the debtor-tenant fails to assume or reject the lease within the 120 day period, and no extension is granted, the lease is deemed rejected. This is a significant provision for landlords. To be proactive, landlords should review all pleadings filed in the tenant’s bankruptcy proceeding to see if the debtor-tenant sought an extension of time to assume or reject. Additionally, landlords should review the tenant’s motions to assume, motions to assume and assign, as well as motions to reject leases. The exhibits to these motions often contain schedules identifying the leases affected by the motion.

2. How does the “automatic stay” of the Bankruptcy Code apply to landlords?

The automatic stay is one of the most powerful protections provided to debtors in a bankruptcy proceeding. The stay acts as an injunction that prohibits creditors (including landlords) from commencing or continuing any proceeding against the debtor which could have been commenced prior to the bankruptcy. Before a landlord seeks to enforce its rights under the lease (such as through eviction, termination or foreclosure), the landlord should seek “relief” from the automatic stay by filing a motion with the bankruptcy court.

It is important for landlords to realize that the automatic stay becomes effective without notice or a hearing. Were a landlord to be found in violation of the automatic stay, the debtor-tenant may be able to recover actual damages from the landlord, including attorneys’ fees. If the violation is found to be intentional, the debtor-tenant may recover punitive damages.
 

Continue Reading Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy