The U.S. Court of Appeals for the Eleventh Circuit has affirmed a lower court ruling that lease termination fees can be considered preferential transfers under the Bankruptcy Code, subject to avoidance. The court’s holding reinforces concerns over whether landlords can structure lease terminations in a manner that protects them from preference recovery.

Last year, a federal district court in Georgia held that payments pursuant to a “lease termination agreement” constituted payments on account of antecedent debt, giving rise to potential preference claims under Section 547 of the Bankruptcy Code. See Midwest Holding # 7, LLC v. Anderson, 387 B.R. 892 (N.D. Ga. 2008), as reported by Derek J. Baker, “Termination Fees,” CRaB Alert, November 2008, p. 12. Following the district court’s decision, the landlord appealed to the Eleventh Circuit, which adopted the reasoning of the lower court. See Midwest Holding #7, LLC v. Anderson (In re Tanner Family, LLC), 556 F.3d 1194 (11th Cir. 2009). The Eleventh Circuit confirmed that payments made pursuant to a lease termination agreement are payments made as a result of the previously existing (and to be terminated) lease agreement.

Because the obligations to pay rent under that lease preceded the payment made pursuant to the termination agreement, the payments could be fairly construed as “on account of” the previously existing lease obligation. Therefore, the payments could constitute payments “on account of antecedent debt” and could qualify as potential preferential transfer under Section 547 of the Bankruptcy Code.

The Eleventh Circuit’s conclusion reinforces concerns we raised in our discussion of the district court’s decision in Midwest Holding—that landlords may have difficulties structuring lease-termination clauses that successfully protect them from preference recovery actions.