In the Spotlight: Bankruptcy Strategies for Commercial Landlords, Tenants, Lenders, and Real Estate Investors

Rejection

By statute, the rejection of a lease results in a breach of the lease, and terminates the bankrupt tenant's obligation to perform under the lease. Rejection also allows the landlord to assert a claim for damages, and may also terminate the leasehold estate. Regardless of the actual date of rejection, the breach is deemed to have occurred immediately prior to the filing date, and gives rise to an unsecured claim by the landlord for damages. In a Chapter 7 or Chapter 11 case, the bankrupt tenant or the bankruptcy trustee must generally assume or reject a lease of non-residential real property before the earlier of: 1) 120 days after the filing date of a Chapter 11 proceeding; or 2) the date of the entry of an order confirming a plan. The court may extend this 120-day period prior to its expiration for an additional 90 days on motion by the debtor or trustee for cause, but may not grant any further extensions without the written consent of the affected lessor.

Strategy Consideration One

Section 365(d)(4) of the Bankruptcy Code provides that, upon rejection, “the trustee shall immediately surrender that nonresidential real property to the lessor.” Nevertheless, some courts have taken the view that rejection is only a breach of the lease, and does not necessarily terminate the lease itself. Generally, termination is better for the landlord as it clearly ends the leasehold estate and should eliminate the derivative rights of third parties such as a subtenant. Accordingly, a landlord should attempt to obtain a specific provision in the bankruptcy court order rejecting the lease, confirming the language of the statute and providing that the lease is deemed terminated, directing the tenant to vacate and surrender the leasehold premises to the landlord as of a specific date, and expressly terminating the rights of all subtenants or any other parties that hold under or through the bankrupt tenant.

Strategy Consideration Two

Because some courts have held that rejection does not necessarily terminate the lease, it may not always be clear if the rights of a subtenant terminate or continue upon rejection of the overlease. Even if a rejection order is tantamount to termination of the tenant's leasehold, an anomalous situation could exist where the tenant must surrender the leased premises to the landlord, but a subtenant could continue to have rights to use the premises it subleases from the tenant. This is because the Bankruptcy Code gives a lessee of a debtor (i.e., a sublessee) rights to continue to use the subleased premises even if the overlease and the sublease are rejected by the bankrupt tenant. To avoid this issue, the landlord should provide in any consent to a sublease that rejection of the overlease in a bankruptcy proceeding terminates the subtenant's rights.

Strategy Consideration Three

Circumstances may arise where there is a compelling reason for the landlord to know whether the tenant intends to reject the lease or assume and possibly assign the lease to a third party before the expiration of the statutory time limit given to the tenant to make its determination. To accommodate this reality, the Bankruptcy Code authorizes the court, on motion by a landlord, to fix a time within which the tenant must determine whether to assume or reject its lease. Generally speaking, as long as the tenant is paying and performing its obligations under its lease, the bankruptcy court will not be receptive to such a motion. By contrast, if the landlord can show that it faces substantial economic or other harm if a decision is not made on a more immediate basis, it is possible that the bankruptcy court would compel the tenant to make an earlier decision.

Strategy Consideration Four

The Bankruptcy Code requires a tenant to perform all of the obligations after the filing date under any unexpired nonresidential real property lease until such lease is assumed or rejected. Courts differ, however, as to precisely when a lease is considered rejected. Some courts hold that rejection requires the entry of a court order authorizing the rejection, while others hold that rejection occurs when the tenant's intent to reject is communicated to the landlord, even if it is not authorized by the bankruptcy court until later. The landlord should pay careful attention to the court order rejecting the lease and attempt to have the order state that rejection is effective on the date that the order is entered and not an earlier date. The landlord will thus be in a better position to assert an administrative expense claim for any unpaid postpetition rental or other obligations owing through the date of rejection.

Strategy Consideration Five

As noted in Part One of this series, the Bankruptcy Code provides a cap on the amount of the landlord's claim for rejection. The cap is calculated on the basis of the rental rate provided for in the lease. Some courts have held, however, that the “cap” does not limit the landlord's claim for items that are not considered rent. For example, repairs and maintenance might not be subject to the cap. Since the law on measuring a landlord's rejection claim is not entirely uniform, a landlord facing a lease rejection claim should be sure to consult a bankruptcy practitioner for assistance in maximizing the value of its rights.

Jeffrey Rich is a partner in the New York office of K & L Gates LLP. He has more than 35 years' experience in the areas of creditors' rights, restructurings and bankruptcy representing financially distressed companies and individual debtors, trustees, lenders, asset purchasers, landlords, creditors, and creditors' committees.

This is the second in a series dealing with the subject of bankruptcy strategies and considerations for commercial landlords, tenants, lenders and real estate investors. These alerts are intended to highlight for our readers some of the key issues they should consider in connection with the subjects discussed.

Strategies for Landlords in Connection with Rejection of
Non-Residential Real Estate Leases

When a commercial tenant files for relief under the Bankruptcy Code, the bankrupt tenant has three choices with respect to its real estate leases. The tenant can: 1) reject the lease; 2) assume the lease; or 3) assume the lease and assign it to a third party. This alert is intended to address the implications of a tenant's decision to reject its non-residential real estate leases.

Rejection

By statute, the rejection of a lease results in a breach of the lease, and terminates the bankrupt tenant's obligation to perform under the lease. Rejection also allows the landlord to assert a claim for damages, and may also terminate the leasehold estate. Regardless of the actual date of rejection, the breach is deemed to have occurred immediately prior to the filing date, and gives rise to an unsecured claim by the landlord for damages. In a Chapter 7 or Chapter 11 case, the bankrupt tenant or the bankruptcy trustee must generally assume or reject a lease of non-residential real property before the earlier of: 1) 120 days after the filing date of a Chapter 11 proceeding; or 2) the date of the entry of an order confirming a plan. The court may extend this 120-day period prior to its expiration for an additional 90 days on motion by the debtor or trustee for cause, but may not grant any further extensions without the written consent of the affected lessor.

Strategy Consideration One

Section 365(d)(4) of the Bankruptcy Code provides that, upon rejection, “the trustee shall immediately surrender that nonresidential real property to the lessor.” Nevertheless, some courts have taken the view that rejection is only a breach of the lease, and does not necessarily terminate the lease itself. Generally, termination is better for the landlord as it clearly ends the leasehold estate and should eliminate the derivative rights of third parties such as a subtenant. Accordingly, a landlord should attempt to obtain a specific provision in the bankruptcy court order rejecting the lease, confirming the language of the statute and providing that the lease is deemed terminated, directing the tenant to vacate and surrender the leasehold premises to the landlord as of a specific date, and expressly terminating the rights of all subtenants or any other parties that hold under or through the bankrupt tenant.

Strategy Consideration Two

Because some courts have held that rejection does not necessarily terminate the lease, it may not always be clear if the rights of a subtenant terminate or continue upon rejection of the overlease. Even if a rejection order is tantamount to termination of the tenant's leasehold, an anomalous situation could exist where the tenant must surrender the leased premises to the landlord, but a subtenant could continue to have rights to use the premises it subleases from the tenant. This is because the Bankruptcy Code gives a lessee of a debtor (i.e., a sublessee) rights to continue to use the subleased premises even if the overlease and the sublease are rejected by the bankrupt tenant. To avoid this issue, the landlord should provide in any consent to a sublease that rejection of the overlease in a bankruptcy proceeding terminates the subtenant's rights.

Strategy Consideration Three

Circumstances may arise where there is a compelling reason for the landlord to know whether the tenant intends to reject the lease or assume and possibly assign the lease to a third party before the expiration of the statutory time limit given to the tenant to make its determination. To accommodate this reality, the Bankruptcy Code authorizes the court, on motion by a landlord, to fix a time within which the tenant must determine whether to assume or reject its lease. Generally speaking, as long as the tenant is paying and performing its obligations under its lease, the bankruptcy court will not be receptive to such a motion. By contrast, if the landlord can show that it faces substantial economic or other harm if a decision is not made on a more immediate basis, it is possible that the bankruptcy court would compel the tenant to make an earlier decision.

Strategy Consideration Four

The Bankruptcy Code requires a tenant to perform all of the obligations after the filing date under any unexpired nonresidential real property lease until such lease is assumed or rejected. Courts differ, however, as to precisely when a lease is considered rejected. Some courts hold that rejection requires the entry of a court order authorizing the rejection, while others hold that rejection occurs when the tenant's intent to reject is communicated to the landlord, even if it is not authorized by the bankruptcy court until later. The landlord should pay careful attention to the court order rejecting the lease and attempt to have the order state that rejection is effective on the date that the order is entered and not an earlier date. The landlord will thus be in a better position to assert an administrative expense claim for any unpaid postpetition rental or other obligations owing through the date of rejection.

Strategy Consideration Five

As noted in Part One of this series, the Bankruptcy Code provides a cap on the amount of the landlord's claim for rejection. The cap is calculated on the basis of the rental rate provided for in the lease. Some courts have held, however, that the “cap” does not limit the landlord's claim for items that are not considered rent. For example, repairs and maintenance might not be subject to the cap. Since the law on measuring a landlord's rejection claim is not entirely uniform, a landlord facing a lease rejection claim should be sure to consult a bankruptcy practitioner for assistance in maximizing the value of its rights.

Jeffrey Rich is a partner in the New York office of K & L Gates LLP. He has more than 35 years' experience in the areas of creditors' rights, restructurings and bankruptcy representing financially distressed companies and individual debtors, trustees, lenders, asset purchasers, landlords, creditors, and creditors' committees.