Historically, a debtor-tenant had the upper hand over its commercial landlord in the bankruptcy arena. Prior to the 2005 amendments to the bankruptcy code, a debtor-tenant had sixty days within which to assume or reject an unexpired non-residential real property lease. If the debtor-tenant assumed the lease, the lease became a binding obligation on the debtor-tenant post bankruptcy filing. However, if the debtor-tenant rejected the lease, the debtor-tenant was released from all obligations under the lease and the landlord was left with only a "capped" general unsecured claim against the bankruptcy estate for the damages resulting from the early termination. Furthermore, and much to the chagrin of the landlord, a debtor-tenant often extended the sixty day time period within which to assume or reject through to the confirmation hearing on the debtor-tenant's reorganization plan, which was often many years after the bankruptcy was filed. The extensions of time, which were routinely granted by the courts, coupled with the right to reject, frustrated landlords and often delayed the landlords' ability to exercise their rights for years. Clearly, the playing field was tilted in favor of the debtor-tenant. The Amended Bankruptcy Code (the "Amended Code") has attempted to balance the power between the debtor-tenant and the commercial landlord and level the playing field between the two, but, did it succeed?
Assumption
Whether to assume or reject a lease is one of most important decisions a debtor-tenant will need to make within its bankruptcy case and courts are generally deferential to a debtor-tenant's business judgment. If the debtor-tenant assumes a lease, the lease becomes a binding obligation upon the debtor-tenant requiring the debtor-tenant to completely and timely perform all of its obligations under the lease post-filing (as opposed to rejecting the lease and being released from its obligations under the lease). Under the pre-amended bankruptcy code (the "Old Code"), if the debtor-tenant failed to completely and timely perform its obligations under the lease after it had assumed the lease, or, rejected the lease post-assumption, the landlord was entitled to an un-capped administrative claim (a claim, with priority over all other claims, entitled to be paid in full) against the estate. Traditionally, the landlord's claim for a post-assumption rejection of a lease consisted of, among other things, all rent due and owing under the entire lease term. Therefore, a post-assumption rejection of a lease would result in a claim against the estate by the landlord that often reached into the millions of dollars much to the detriment of other creditors. To guard against a post-assumption rejection and the large administrative claim associated with it, debtor-tenants often delayed in making the decision on assumption or rejection.
Under the Old Code, a debtor-tenant had 60 days to assume or reject a nonresidential real property lease, however this time period was often extended by the courts on numerous occasions during a case so that the decision to assume or reject would not need to be made until the confirmation hearing on the debtor's reorganization plan, which was often many years after the bankruptcy was filed. This dynamic has changed under the Amended Code. The Amended Code now provides that a debtor has only 120 days after the bankruptcy petition is filed within which to assume or reject. The Amended Code also provides that this 120-day period can only be extended one time, for a period of 90 days for cause. After that one 90-day extension, the debtor-tenant can extend the time to assume or reject only if it has the landlord's consent. The result: a debtor-tenant will have, at best, 210 days (seven months) to assume or reject (instead of years) and the landlord will have significant bargaining leverage (essentially a veto and rejection power of its own) over the debtor-tenant and over the issue of whether or not the time period to assume or reject is extended beyond the 210 days.
So, from the landlord's perspective, the Amended Code seemed to be heading in the right direction. However, with one hand, the Amended Code giveth, but with the other, it taketh away. With its new shortened time period for assumption/rejection, it appeared that Amended Code had placed the debtor-tenant and its creditors in a precarious situation. Forcing the debtor-tenant to make earlier (and possibly premature) decisions on assumption/rejection was putting the debtor-tenant and its creditors at significant risk of a post-assumption rejection. To address this issue, the Old Code was also revised to limit the administrative claim of a landlord whose lease is rejected after assumption to the sums due under the lease over a two (2) year period instead of the entire lease term (as was the case under the Old Code). So, while the landlord was given quasi-veto power, the debtor-tenant was given a safety net to protect itself in the event it had to assume a lease earlier than desired.
Rejection
The Amended Code did not revise or otherwise change a debtor-tenant's right to reject any or all of its leases and since courts ruling on motions to reject leases are typically deferential to a debtor-tenant's business judgment, a debtor-tenant will continue to enjoy an unfettered right to reject. However, the fact that a debtor can reject an unexpired lease is only one-half of the equation. The other half of that equation (and possibly the real benefit of the right to reject), which also went unchanged in the Amended Code, is that the damages owed to a landlord as a result of the rejection are capped - thus minimizing the damages the debtor-tenant must pay for essentially breaching the lease. The debtor-tenant therefore continues to possess a powerful tool in its reorganization efforts.
The Landlord's Rejection Claim
If a debtor-tenant rejects its unexpired lease with its landlord, and assuming there has been no previous assumption, a landlord's claim consists of three components: 1) an uncapped administrative claim for rent for the period between the bankruptcy filing date and the date of rejection; 2) an uncapped unsecured claim for the rent due as of the date of the bankruptcy filing (the past due rent as of the filing date); and, 3) an unsecured claim for damages resulting from the termination of the lease (typically, future rent). It is this third, future rent component of the landlord's claim (often the largest portion of the landlord's claim) that is subject to a cap.
A landlord's damages resulting from the termination of a lease (again, typically future rent) are capped at one year's worth of rent or 15% of the rent over a three year period. It is important to note however that claims for damages arising out of physical damage to the leased property are not subject to the "cap".
Conclusion
So, did the Amended Code do enough to level the playing field or did it tilt the field too far in favor of the landlord? Landlords have clearly gained new power under the Amended Code. Landlords can now force debtor-tenants to make earlier decisions on assumption and rejection. The effect and impact of this accelerated decision-making on a bankruptcy case is difficult to overstate. However, by providing the right to reject and the capping of damage claims, the Amended Code continues to provide effective reorganization tools to a debtor-tenant. Whether the Amended Code did just enough or too much probably depends on what side of the field you play on, but what is certain is that the playing field has changed.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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