When a lessee elects to remain in possession of real property after rejection of the lease under Section 365(h)(1)(A)(ii), the tenant’s parent remains liable on a guarantee of the tenant’s obligations despite rejection of the lease, according to the Sixth Circuit.
The facts were complicated but boil down to this: The soon-to-be debtor owned a manufacturing plant and an adjacent power plant. Before bankruptcy, the debtor sold the power plant to the tenant and gave the tenant a 10-year lease for the underlying real estate. The tenant’s parent corporation guaranteed the tenant’s obligations under the lease.
The lease required the tenant to maintain the power plant in the same condition as when the lease commenced.
The debtor’s confirmed chapter 11 plan conveyed title to the land to a trust. The debtor terminated operations at the manufacturing plant and therefore purchased no power from the tenant. At the end of the term of the ground lease, the tenant abandoned the power plant.
The trust sued the tenant and its parent in federal district court in Detroit. According to the complaint, the parent directed the tenant to cease performing maintenance when the debtor stopped purchasing power. For the lack of maintenance over several years, the complaint alleged that the power plant sustained significant damage, including water damage causing dispersal of asbestos.
The complaint sought damages for failing to maintain the power plant in the condition it was in when the lease commenced.
On motion under Rule 12(b)(6), the district court dismissed the complaint, believing that the guarantee evaporated when the lease was rejected. The district court also dismissed the trust’s veil-piercing claims against the parent. The district court allowed claims to stand against the tenant.
Sixth Circuit Judge Richard Allen Griffin reversed in an opinion on January 5. The claim on the guarantee turned on whether the guarantee survived rejection of the lease.
Judge Griffin said that release rejection is only a breach of the lease, not a termination. When a tenant decides to continue the lease under Section 365(h)(1)(A)(ii), he said that the tenant “waives the debtor’s breach and instead opts to continue under the lease’s existing terms and obligations, albeit with a more limited right of recovery against its landlord for breaches.”
If “the tenant elects to retain the benefits of that contract through § 365(h),” Judge Griffin went on to say in a footnote, “it must also assume the contract’s obligations.” The parent, he said, “offer[s] no reason why § 365 would allow a tenant, but not a debtor, to assume the benefits of a contract while rejecting its burdens or assume integrated contracts on a piecemeal basis.”
Judge Griffin therefore revered the district court and ruled that the guarantee survived rejection of the lease.
The opinion by Judge Griffin also contains important holdings with regard to veil-piercing under Michigan law. Unlike other states, he said that “Michigan recognizes that a breach of contract can satisfy the ‘fraud or wrong’ requirement of its veil-piercing doctrine.”
Judge Griffin reversed dismissal of the veil-piercing claims. “By allegedly directing its wholly owned subsidiary to stop maintaining” the power plant “and thereby breach[ing] its contractual obligations,” he held that the complaint stated facts sufficient to survive a motion to dismiss.
Judge Griffin was careful to say that the ruling only meant that the complaint was sufficient, not that the allegations in the complaint alone were enough to pierce the corporate veil. The plaintiff, he said, must show that the tenant was a sham or mere agent or instrumentality of the parent.
The allegations in the complaint, Judge Griffin said, allowed the court to draw reasonable references defeating a motion to dismiss. The parent’s argument for dismissal was “better suited for the summary judgment context,” he said.
In addition, the opinion contains important law describing when related contracts are severable under Michigan law.
When a lessee elects to remain in possession of real property after rejection of the lease under Section 365(h)(1)(A)(ii), the tenant’s parent remains liable on a guarantee of the tenant’s obligations despite rejection of the lease, according to the Sixth Circuit.
The facts were complicated but boil down to this: The soon-to-be debtor owned a manufacturing plant and an adjacent power plant. Before bankruptcy, the debtor sold the power plant to the tenant and gave the tenant a 10-year lease for the underlying real estate. The tenant’s parent corporation guaranteed the tenant’s obligations under the lease.
The lease required the tenant to maintain the power plant in the same condition as when the lease commenced.
The debtor’s confirmed chapter 11 plan conveyed title to the land to a trust. The debtor terminated operations at the manufacturing plant and therefore purchased no power from the tenant. At the end of the term of the ground lease, the tenant abandoned the power plant.