In this edition of the Landlord’s Corner, we review various cases that address the (i) rights of landlords to recover their property post-rejection, (ii) whether payments pursuant to a termination of lease agreement constitute preferential transfers and (iii) whether a lease could be retroactively rejected in the absence of a formal motion to reject.

In In re Deli Den, LLC, 425 B.R. 725 (Bankr. S.D. Fla. 2010), the court construed how quickly and through which judicial process the debtor was required to return property to the landlord after rejection of the lease consistent with the provisions of section 365(d)(4) of the Bankruptcy Code. Section 365(d)(4) provides protections for commercial landlords, requiring a trustee or debtor-in-possession to “immediately surrender” the premises upon rejection of the lease. If the trustee or debtor does not accept or reject a lease within 120 days of the bankruptcy petition filing, the lease will be deemed to be rejected. In Deli Den, the debtor had failed to act within 120 days; thus, the lease was deemed rejected. Rather than surrendering the premises, however, the debtor argued that the landlord was required to seek an unlawful detainer/recovery in state court, provided that the landlord ultimately obtained relief from the automatic stay to do so. In other words, the debtor asserted that, despite exercising the benefits of a bankruptcy case and rejecting the lease, the debtor could remain in possession until such time as the landlord otherwise sought to exercise its state law rights to recover the premises.

In response, the landlord argued that the plain language of section 365(d)(4) of the Bankruptcy Code required the debtor to “immediately surrender” the property to the landlord upon rejection of the lease. The court sided with the landlord, noting that the language of the Bankruptcy Code clearly provides for the “immediate surrender” of the property, and the landlord should not be required to resort to state courts to recover its property. Moreover, bankruptcy courts should exercise their broad equity powers in favor of granting a surrender order to a lessor who, under the terms of the Bankruptcy Code, clearly deserves one.  

This case further supports landlords in their attempt to immediately recover property upon its rejection by a debtor in a bankruptcy case.

In McHale v. Publix Supermarkets, Inc. (In re Luxury Ventures LLC), 425 B.R. 680 (Bankr. M.D. Fla. 2010), the Bankruptcy Court considered whether payments made pursuant to a termination agreement could otherwise be excepted from the preference statute. Most landlords are aware that payments made by a debtor in the 90 days prior to the bankruptcy case can be recouped to the debtor’s estate to the extent that those payments are made on account of a pre-existing indebtedness. While the statute imposes the “strict” liability to return certain pre-petition payments, those payments can be defended to the extent that the payments were made “in the ordinary course of business.”

In this case, the debtor and the landlord entered into a pre-petition agreement pursuant to which the landlord agreed to allow the debtor to terminate the lease, provided that the debtor pay the upcoming monthly rental payment as and when due. In the succeeding month, the debtor made the payment as required under the lease and the termination agreement and, at the conclusion of the month, tendered the keys to the landlord, thereby terminating the lease in accordance with the termination agreement.

After the bankruptcy filing, a representative of the debtor’s estate sought to recover the final payment, asserting that the payment was a preference. The landlord argued that the payment was made in the ordinary course of business and therefore was subject to that defense as a matter of law. After hearing arguments, the court concluded that the payment was made pursuant to the terms of the lease and the termination agreement. As a result, the payment was on ordinary business terms in accordance with ordinary business practices. Therefore, the payment was immune from any recovery as a statutory preference.

This case is unique, in the sense that the termination agreement required the debtor to continue to make lease payments pursuant to the terms of the existing lease agreement for a set period of time. Therefore, in the event that landlords are negotiating with tenants about possible terminations – and seek to insert “preference protections” in such agreements – the better course may be to link the termination to the ongoing compliance with lease terms for a specific period of time, ensuring the continuity of the ordinary business practices and thereby possibly insulating the payments from a subsequent preference attack.

In Tenucp Property, LLC v. Riley (In re GCP CT Sch. Acquis., LLC), No. MB 09-065, 2010 WL 2044871 (Bankr. 1st Cir. May 24, 2010), the court reviewed the authority of a bankruptcy court to permit the rejection of a lease retroactively and its effect on the claim of a landlord for post-petition, pre-rejection rent. In this case, the debtor, which operated a number of broadcasting schools, commenced the bankruptcy case after a liquidity event close to the end of a semester. Immediately upon the chapter 7 filing, the chapter 7 trustee sought authority to operate the business on an interim basis. As a result of the “teach out,” the students of the schools would be permitted to finish and earn their completion certificates, and the trustee would be able to market the business for sale. As part of the motion seeking authority to operate the business on an interim basis, the trustee advised the court that the “teach out” would be for a very short period of time.

Shortly thereafter, the trustee was able to identify a potential buyer for the majority of the business; however, the buyer was not interested in assuming certain leasehold interests. The trustee filed a motion seeking authorization to conclude the sale and, as part of that motion, enumerated those leases that the buyer did not want. Thereafter, the trustee filed a motion to extend the period to assume or reject unexpired non-residential real property leases and noted that any lease not otherwise assumed as a result of the sale would be deemed rejected June 4, 2009.

The sale closed and immediately after the closing, the trustee sent an email to the landlord (Tenucp Property, LLC) advising that all of the assets at the landlord’s location had been removed as of May 23, 2009. The trustee provided an accounting of the trustee’s calculation of the aggregate obligations due. Thereafter, the trustee sent a letter to the landlord enclosing a payment for the occupation of the premises through May 23, 2009. The payment was alleged to be “in accord and satisfaction of all administrative rent and expenses 4/4- 5/23/09.” The landlord received and thereafter cashed the check June 9, 2009. The landlord subsequently filed a motion seeking payment of rent through July 13, 2009 (the statutory date the lease would be deemed rejected).

The court noted that non-residential real property leases receive special treatment under the Bankruptcy Code. A trustee is obligated to assume or reject a lease within a specified period of time. Also, the trustee is required to timely perform all the obligations under that lease – including the obligation to pay rent at the contract rate – until the lease is rejected. The court noted that the main issue concerned “the effective date of rejection,” since that date determines when the obligation to pay rent ceases pursuant to the Bankruptcy Code. In reviewing other case holdings, the court noted that bankruptcy court approval is a condition precedent to the rejection of any non-residential real property lease. While noting that rejection may not take effect until judicial approval is secured, the approving court nonetheless has the equitable power to order that the rejection operate retroactively.

The landlord first argued that no rejection was obtained because no formal motion seeking rejection had been filed. The court held that a formal motion to reject the lease was not necessary. Rather, the Bankruptcy Code requires only prior notice of the trustee’s intent to reject. The court reviewed the series of motions filed by the trustee – including the motion to extend the period to assume or reject leases – which the court held put the landlord on notice that the trustee intended to reject. Further, the court concluded that once the landlord had notice of the trustee’s intent to sell the business, the landlord was on notice that its lease might be affected. The court concluded that while no formal rejection motion was filed, all the other motions filed in the case – all of which were served on the landlord – had the effect of providing the landlord with sufficient notice of the trustee’s intent to reject the landlord’s lease.

The landlord further contended that even if appropriate notice of rejection was found, the Bankruptcy Court could only allow “retroactive” rejection to take effect as of the motion “filing date” or the “order date.” The court concluded that all prior precedent establishes that bankruptcy courts have the equitable power to retroactively determine the appropriate effective date of rejection. The court also concluded that there was no legal basis to limit the date that could be the appropriate effective date. Rather, the Bankruptcy Court could take into account all the facts and circumstances to determine the appropriate date, once the court had concluded that appropriate notice was given of the lease’s rejection. The court concluded, however, that the Bankruptcy Court did err by selecting the date it chose for the effective rejection date, and remanded the case to “re-determine” the appropriate lease rejection date.

This case makes clear that landlords must remain vigilant in their review of their tenant’s bankruptcy dockets. Landlords must monitor actions in their tenant’s bankruptcy case to determine whether to make an inquiry as to any possible impact on the landlord’s lease. While this case places a burden on the landlords to engage in more vigorous review and inquiry, it also makes clear that the court may not arbitrarily determine when a rejection is deemed effective. Rather, the court must take into account all the facts necessary to ensure that there has been proper notice of the rejection prior to being effective, and that the rejection will not be effective until the estate representative has appropriately evidenced intent to relinquish any rights in connection with the property, and has complied with its bankruptcy obligations of surrender.