If the debtor-tenant seeks to terminate and surrender the lease, that is “reject it”, the landlord may be entitled to a “rejection damage” claim.  A landlord is not entitled to the full amount of unpaid obligations for the balance of the lease.  Instead, Section 502(b)(6) limits the recovery a landlord may receive for “rejection damages.” Under Section 502(b)(6) of the Bankruptcy Code, the landlord is entitled to rent due under the rejected lease for the greater of (i.) one year’s rent, or (ii.)  fifteen percent (15%) of the rent due under the lease, not to exceed three years’ rent.  Unlike the administrative rent claim, a rejection damage claim is a general non-priority unsecured claim paid only after all other claims.

The landlord’s rejection damage claim is capped under Section 502(2)(b)(6), but the landlord is entitled to include all amounts that constitute “rent” under the lease.  Items that may include “rent” include utility fees, common area maintenance charges and taxes.

The Bankruptcy Code views a rejected lease as one that is in breach by the tenant.  To preserve its rejection damage claim, the landlord needs to prepare and file a proof of claim.  This differs from the procedure for administrative rent claims, which generally requires the landlord to file a motion for allowance and payment of the administrative rent claim.  Once the rejection damage claim is properly filed with the court, the claim is deemed allowed unless the debtor-tenant, or another interested party, files an objection to the claim.  Only claims that are “allowed” are eligible for payment, and again, only if funds are available.

Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Samsonite Corporation, one of the world’s largest luggage manufacturers, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on September 2, 2009.  According to Samsonite’s Declaration in Support of First Day Motions, the company “does not anticipate that any of its customers or suppliers will be materially affected by this [bankruptcy] filing.”  While this is good news for Samsonite’s customers, the outcome for the company’s landlords is less certain.

As stated in its Declaration, Samsonite leases 173 retail stores in 38 states.  Due to a sudden drop in consumer demand for travel products, Samsonite experienced a significant reduction in its cash flow.  As a result, the company engaged in a restructuring process that culminated in the filing of its bankruptcy petition in Delaware.  Through bankruptcy, Samsonite intends to reject up to 84 leases for those stores the company deems unprofitable.

Landlords dealing with commercial tenants in bankruptcy face a host of issues, including administrative rent, rejection damages and adequate assurance.  A previous post on this blog titled “Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy” provides a good introduction to the issues that confront a landlord when a commercial tenant files for bankruptcy.  Judge Peter J. Walsh, a former Chief Judge of the Delaware Bankruptcy Court, recently issued an opinion in the Sportsman’s Warehouse bankruptcy that provides a very helpful understanding of how bankruptcy courts approach claims for administrative rent and taxes that arise under a lease.  Landlords in Samsonite may find Judge Walsh’s decision particularly relevant as Judge Walsh is also the judge presiding over the Samsonite bankruptcy.

KB Toys filed for chapter 11 bankruptcy protection this morning in the United States Bankruptcy Court, District of Delaware (read the KB Toys Bankruptcy Petition here).  According to its affidavit in support of its bankruptcy motions,  KB operates 277 shores in shopping malls, 40 stores in strip malls and 114 outlet stores (read the KB Affidavit in Support of bankruptcy motions here).  KB lists its annual sales at $480 million.

KB previously filed for bankruptcy in 2004.  During its 2004 bankruptcy, it reduced the number of stores from 1,200 to 650.  I suspect you will see similar store-closings in this bankruptcy.  Whether KB rejects store leases, or assumes the leases,  landlords need to pay close attention to this bankruptcy.  Attached is a link to a previous post I prepared titled "Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy."  This link provides a brief summary of some of the issues landlords should consider when a commercial tenant such as KB files for bankruptcy.

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.

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