Sudden Death in Overtime Part II Whether a Debtor Can Stop Eviction and Assume a Lease That Has Been Terminated Pre-petition

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Dec/Jan 2001

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The first installment of this article (November 2001) discussed cases holding that
the automatic stay stopped eviction proceedings filed before the filing of a bankruptcy
petition. It also set out the changes proposed by the Senate and the House and
their possible effect on the automatic stay. This installment will examine cases holding
that the automatic stay does not stop eviction proceedings and will discuss the possible
effect of the pending legislation on this precedent.

The bankruptcy court for the Western District of Texas held soon after the effective
date of the Bankruptcy Code that the debtor, the holder of an oil and gas lease
that had been terminated prior to the filing of the bankruptcy petition, was not
afforded protection by the automatic relief of §362. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Balcones Oil Co.
Inc., 21 B.R. 36, 39 (Bankr. W.D. Tex. 1981)</a>. The court cited
three pre-Bankruptcy Code cases as authority, including a Fifth Circuit case,
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Industries Inc. v. Schokbeton Products Corp., 466 F.2d 171
(5th Cir. 1972)</a>. The Fifth Circuit in Schokbeton restated what it referred
to as the "Lane Foods doctrine": a debtor's "possession—rather than ownership or legal
title—underlies the exercise of bankruptcy jurisdiction; the temporary continuation of
possession, contingent upon payment for such occupancy," is appropriate. Schokbeton at
177. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lane Foods, supra.</a> The Fifth Circuit, however, found that
the facts before it could not be molded to fit the Lane Foods doctrine because the
debtor had no rights in a franchise that had been terminated pre-petition, and the
debtor "possessed" nothing. Schokbeton Industries at 177.

The landlord in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Policy Realty Corp., 242 B.R. 121 (S.D.N.Y.
1999)</a>, terminated its lease with the tenant when the tenant failed to pay rent.
The premises were used for non-residential, commercial purposes. The lease was
terminated pursuant to an accelerated termination clause in the lease before the end of
the term of the lease. The sub-tenant, realizing that termination of the lease would
also terminate its sublease, filed a bankruptcy petition. The landlord promptly filed
a motion for an order declaring the automatic stay to be inapplicable to the commercial
lease under §§362(b)(10) and 541(b)(2). The bankruptcy court denied the
motion. The landlord appealed to the U.S. District Court; the district court
reversed.

The district court examined the effect of §§362(b)(10) and 541(b)(2)
on a lease of non-residential property. The court at pages 127 and 128 quoted
§541(b)(2), which specifically excludes from the debtor's estate

<blockquote>
any interest of the debtor as a lessee under a lease of non-residential real
property that has terminated at the expiration of the stated term of such lease
before the commencement of the case under this title, and...during the case.
</blockquote>

The court then went on (at page 128) to quote paragraph (b)(10) of §362,
which specifically excludes from the protection of the automatic stay

<blockquote>
any act by a lessor to the debtor under a lease of non-residential real
property that has terminated by the expiration of the stated term of the lease
before the commencement of or during a case under this title to obtain possession
of such property.
</blockquote>

The court concluded after quoting these two provisions that the terms "terminated"
and "stated term" are not limited in any way. The court equated the landlord's
termination of the lease and sub-lease pursuant to the lease's accelerated termination
clause to be the same as termination at the end of the "stated term" of the lease.
Policy Realty Corp. at 128. The court found that the "stated term" of the lease
and sub-lease ended on the first day of the sub-tenant's bankruptcy and were therefore
terminated "during the case." The court held that since the "stated term" of the lease
and sublease ended "during the case," they were not property of the estate under
§541(b)(2) and were not protected by the automatic stay of §362. Policy
Realty Corp. at 128.

The sub-tenant argued that it had an equitable possessory interest in the leasehold
property protected by the automatic stay. The court rejected this argument. The court
pointed out that the sub-tenant was not in physical possession of any of the premises
because the sub-tenant had further sublet all of the commercial space to a variety
of businesses. Policy Realty Corp. at 129. The court also stated that the
sub-tenant's argument, if adopted, would undermine the purpose of §§362(b)(10)
and 541(b)(2). The court further stated that the language of §362(b)(10)
clearly indicates that it is not necessary for a landlord to move in bankruptcy court
to vacate the automatic stay when the debtor is operating under a lease of
non-residential real property that has terminated by the expiration of the stated term
during a bankruptcy case. Policy Realty Corp. at 129.

In Policy Realty Corp., the sub-tenant did not have actual physical possession
of any part of the premises, and had little or no basis for the argument that it
had an equitable interest in real property. Some courts, however, have found that
a tenant who did have physical possession of a non-residential property did not have
anything of value that the tenant-debtor could assume under §365, and therefore had
nothing that would be protected by the automatic stay of §362. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Island
Helicopters Inc., 211 B.R. 453, 464 (Bankr. E.D.N.Y. 1997)</a>.

In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Neville, 118 B.R. 14 (Bankr. E.D.N.Y. 1990)</a>, the
tenant operated a senior citizens residence center. In May 1989, the landlord
commenced an eviction proceeding against the tenant, claiming he was a holdover tenant.
The landlord obtained a judgment for possession. The state court issued a warrant of
eviction on Oct. 30, 1989. The tenant still occupied the premises on May
21, 1990, when he filed a chapter 11 petition. On May 23, 1990, the
sheriff evicted the debtor-tenant from his place of business. The tenant, of course,
argued in bankruptcy court that he had an equitable possessory interest in the premises
that was protected by the automatic stay. The court rejected this argument at page
18 of the opinion, saying:

<blockquote>
The legislative history of §362 (b)(10) indicates that it was intended
to permit landlords to proceed promptly in state court to reclaim possession of
the non-residential lease premises where the lease expired by its own term and
to finalize landlord/tenant disputes such as the one that is the subject of this
case. See S. Rep. No. 98-65, 98th Congr., 1st Sess. 68
(1983). For this court to accept the debtor's argument that "his equitable
possessory interests were protected by the automatic stay" would result in
nullifying §362(b)(10), which was purposely placed into the Bankruptcy
Code to deal with situations such as this.

Pursuant to §365(c)(3), the debtor retained no leasehold interest that
could be assigned. There was no possibility of remaining in possession for any
considerable length of time. The debtor's naked possessory interest, if any, has
no value to this debtor's estate, and to reimpose a stay against the landlord
would not benefit this debtor's estate. Once a lease has been terminated, the
bankruptcy court does not have the power to revive it even through its equitable
powers. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Erie Builders Concrete Co., 98 Bankr. 737 (Bankr.
W.D. Pa. 1989)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re West Pine Const. Co., 80 Bankr. 315
(Bankr. E.D. Pa. 1987)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Darwin, 22 Bankr. 259
(Bankr. E.D.N.Y. 1982)</a>.

</blockquote>

The Neville case is limited to the interpretation of §§362(b)(10) and
365(c)(3) as they apply to non-residential tenancies. It does not specifically
mention §541.

The foregoing cases concern non-residential tenancies. Some courts have found that
the automatic stay also does not stop a landlord from evicting a tenant from a
residence when the tenancy was terminated prior to bankruptcy.

The court in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Smith, 105 B.R. 50 (Bankr. C.D. Cal.
1989)</a>, faced the issue of whether a tenant in a residential tenancy had any
property interest in a leasehold that had been terminated prior to bankruptcy, and the
court stated bluntly that the "debtor's retention of physical possession of the apartment
is not a property interest recognized by law." Smith at 54. In Smith, the tenant
entered into a lease of an apartment in 1988. On or about June 1, 1989,
the tenant failed to pay her rent. On June 10, 1989, pursuant to California
law, the landlord served the tenant with a Notice to Pay Rent or Surrender Possession
of Premises. Smith at 51. The tenant did not pay the past-due rent. The landlord
filed a complaint for unlawful detainer in the state court. The tenant did not appear
or otherwise respond to the complaint. The landlord obtained a judgment on July 17,
1989, awarding him possession of the apartment. The tenant filed a chapter 7
petition on July 17, 1989, before she could be physically evicted. The landlord
was listed as the only creditor on the tenant's schedules. Smith at 51.

The Smith court relied in part on the Ninth Circuit's interpretation of California
state law in the decision of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Windmill Farms Inc., 841 F.2d 1467
(9th Cir. 1988)</a>. The Ninth Circuit in Windmill found that under California
law, when the lease is terminated, the tenant does not retain property interest in
the leasehold estate except the right to seek relief from forfeiture under the
California Code of Civil Procedure. The court, after reviewing Windmill Farms, held
that the bankruptcy estate of the debtor-tenant had no property interest in the
leasehold estate since the leasehold had been terminated pre-petition. Smith at 54.

The Smith court conceded that the tenant might arguably retain a property interest
because of the California right to seek relief from forfeiture, but found that such
remedy was a hollow one in bankruptcy because the tenancy had no value and the trustee
did not have any assets that would enable him to fulfill the condition of the
anti-forfeiture rule, namely the full payment of rent due. Smith at 54.

The court in Smith then examined the impact of the automatic stay, and stated at
page 55 of the opinion:

<blockquote>
The purpose of the stay is to give the bankruptcy estate and its fiduciary,
either the trustee or the debtor-in-possession, an opportunity to gather together
the assets of the estate, determine their value, and liquidate or reorganize
them. This goal of the stay is not achieved by applying it to a landlord's
attempt to regain possession of residential real property wrongfully being held by
a debtor/tenant.
</blockquote>

The court concluded that the stay does not enjoin a landlord from regaining
possession of residential premises from a wrongfully holding over debtor-tenant. Smith

at 55. The court qualified this holding by stating that the landlord could not
enforce any other portion of his unlawful detainer judgment against the debtor and the
bankruptcy estate, including the award of money damages. Smith at 55.

The court in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kennedy, 39 B.R. 995 (C.D. 1989)</a>, confronted
the issue of whether a bankruptcy court has jurisdiction to conduct eviction proceedings
when the debtor has only naked possession of property. The case did not involve a
lease. The debtors owned certain real property, which they used as their residence.
They filed a chapter 11 petition that was later converted to a chapter 7 case.
The holder of a second deed of trust obtained an order in the chapter 11 proceedings
allowing it to foreclose its lien. The creditor conducted a trustee's sale and took
title to the property. The debtors refused to move, and the creditor filed eviction
proceedings in bankruptcy court (not state court). The bankruptcy court entered a
judgment ejecting the debtors from the property. The debtors appealed, claiming that
the bankruptcy court lacked jurisdiction to conduct eviction proceedings because the
property in question was not part of debtors' estate, and therefore that the bankruptcy
court had acted beyond its jurisdiction. The district court agreed, holding that the
debtors did not retain a right to the property after the foreclosure sale. Since the
residence was not property of debtor's estate, the bankruptcy court had lacked
jurisdiction to conduct proceedings concerning it. The district court, although stating
that the automatic stay precluded the creditor from getting possession of property in
which debtors had only naked possession, qualified the application of the stay. The
district court stated that the automatic stay should apply only to property necessary
to a debtor's effective reorganization.

The court in In re Kennedy sets out at page 997 of the opinion why the In
re Lane Foods doctrine excludes the application of the automatic stay to proceedings
to regain possession of property that is not necessary to a debtor's effective
reorganization:

An automatic stay in situations in which a debtor is in bare possession of
property sometimes will be necessary to assure an effective reorganization of the
debtor. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lane Foods Inc., 213 F.Supp. 133,
135-36 (S.D.N.Y. 1963)</a> (court stayed eviction proceedings for short
time to allow the debtor-in-possession, a business reorganizing under chapter
XI, a reasonable opportunity to renegotiate with landlord or to find new
premises. The stay allowed the continued operation of the debtor's business, and
thereby effectuated the object of the bankruptcy proceeding, the rehabilitation of
the debtor). However, when a stay is unnecessary to promote the purposes of
the Act, and when the debtor's estate retains no property right in the property
at issue, the bankruptcy court has no interest whatsoever in the disposition of
the property. The court believes that the exercise of federal jurisdiction under
these circumstances not only imposes a burden on the federal courts in an area
in which no federal interest exists, but also is inconsistent with principles
of federalism.
</blockquote>

Other courts have also tried to reach results that were not inconsistent with the
principles of federalism. These courts have held that a state court judgment terminating
a tenancy should be given preclusive effect. In other words, the state court judgment
terminating a lease precludes applying §362 to ongoing eviction proceedings at the
time of bankruptcy. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lady Liberty Tavern Corp., 94 B.R. 812
(S.D.N.Y. 1988)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Neville, 118 B.R. at 17</a>; and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Scarsdale Tires Inc., 47 B.R. 478, 480 (S.D.N.Y. 1985)</a>. Each
of these cases concerned commercial property leases. Arguably, however, the lease in

Neville could be considered a residential lease since it involved a senior citizen
residence center, but the court treated it as a commercial lease. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Neville,
118 B.R. at 18</a>.

In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Liberty Tavern Corp, supra,</a> the landlord obtained a default judgment in
state court awarding it possession of the premises in question. The state court issued
a warrant of eviction on Dec. 17, 1986. The marshal served a 72-hour
notice of eviction on the tenant on Dec. 19 as required by New York law. The
tenant filed a chapter 11 petition on Dec. 22 before the warrant was executed.
The district court stated that bankruptcy courts should give preclusive effect to a
state court eviction judgment, and cited <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Andrijevic, 825 F.2d
692 (2nd Cir. 1987)</a>, as authority. Lady Liberty at 815. The district
court stated at the conclusion of the opinion (without specifically referring to
§541) that the automatic stay does not operate to enjoin actions affecting property
that no longer belongs to the debtor at the time of bankruptcy. Lady Liberty at
817. The court in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Scarsdale Tires Inc., supra,</a> reached the same
conclusion. Scarsdale Tires at 480. These two cases hold that when the landlord
has obtained a judgment terminating the lease and awards him possession of the
property, the tenant cannot successfully argue that he has an equitable interest in
the property because his right to possession has been foreclosed by the state court
judgment.

Both the Senate and House passed proposed revisions to §362 of the Code. The
Senate and House versions are dissimilar, but both allow a landlord to prosecute
eviction proceedings in state court when the lease involves residential property and if
certain requirements are met. In the House version, a landlord can continue with
an eviction of a residential tenant if the eviction proceedings were initiated prior to
bankruptcy. The House version would also allow a landlord to commence eviction
proceedings after the filing of a bankruptcy petition if the lease has been terminated
prior to bankruptcy. The Senate version would allow the commencement or continuation of
an eviction proceeding involving a residence only when the tenant fails to make a
rental payment that becomes due after the filing of the petition or becomes due in
the 10-day period preceding the date of the filing of a petition. The landlord may
also continue or initiate an eviction of a residential tenant when the debtor has a
month-to-month tenancy. The Senate version would also allow two other more limited
exceptions. They also concern only residential tenancies.

Much of the case law discussed in this installment of the article concerns commercial
tenancies, and perhaps the effect of these cases will not be lessened by the proposed
amendments to §362 of the Code, which concern only residential tenancies.
Presumably, the House version and, to a lesser extent, the Senate version ratify
the courts' reasoning in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kennedy, supra,</a> and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Smith, supra.</a> If
Congress passes the House version of the amendment to §362 of the Code, it is
almost certain that one of the major issues in this area will be whether or not the
landlord properly terminated a residential lease under state law before bankruptcy.

Journal Authors

Keith M. Baker

Journal Date

Saturday, December 1, 2001 - 12:00

Bankruptcy Rule

2001