Courts disagree on whether future liability on a lease counts toward the $7.5 million eligibility limit for Subchapter V.
Not counting future rent liability, Bankruptcy Judge Philip Bentley of New York disagreed with Bankruptcy Judge Klinette H. Kindred of Alexandria, Va., who knocked a debtor out of Subchapter V solely as a result of liability on a long-term lease. See In re Macedon Consulting Inc., 652 B.R. 480 (Bankr. E.D. Va. June 14, 2023). To read ABI’s report on Macedon, click here.
Judge Bentley sided with Bankruptcy Judge Thomas J. Catliota of Greenbelt, Md., who held that contingent liability on a lease is not counted in deciding whether the debtor has more than $7.5 million in debt. See In re Parking Mgmt., 620 B.R. 544 (Bankr. D. Md. 2020).
In Parking Management, the debtor had moved to reject the lease on filing. Declining to consider the motion for rejection is consistent with cases holding that developments after filing don’t affect a debtor’s eligibility for Subchapter V on the filing date. See, e.g., In re Free Speech Systems LLC, 649 B.R. 729, 733 (Bankr. S.D. Tex. March 31, 2023); and In re Dobson, 23-60148, 2023 BL 168846 (Bankr. W.D. Va. May 17, 2023). To read ABI’s reports, click here and here.
Too Much Debt for Sub V
The debtor operated a fertility clinic in midtown Manhattan. Expecting an expansion of the business, the debtor doubled the square footage in the office it was occupying. Plans went awry when the pandemic prevented the debtor from subleasing the new space until the fertility business had grown enough to utilize the additional floors.
Having fallen in arrears on paying rent, the debtor ultimately filed a chapter 11 petition and elected treatment as a small business debtor under Subchapter V. After spending several months negotiating with the landlord, the debtor filed a motion to reject the lease, which Judge Bentley granted.
Meanwhile, the landlord had objected to the debtor’s Subchapter V eligibility, saying there was more than the $7.5 million cap contained in Section 1182(1)(A). Judge Bentley sustained the objection in his November 30 opinion, but not based on long-term lease liability.
Rather, Judge Bentley gauged eligibility by combining the debts that the debtor had scheduled as undisputed and proofs of claim filed by creditors to which the debtor had lodged no objections. As Section 1182(1)(A) requires, Judge Bentley was looking for the “aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition.”
Judge Bentley decided that the debtor was ineligible for Subchapter V because undisputed and scheduled claims exceeded $7.5 million when “grossing up” undisputed, scheduled claims to the amounts sought in the creditors’ proofs of claim to which the debtor had not objected.
The Landlord’s Alternative Argument
Alternatively, the landlord cited Macedon and contended that the debtor had more than $7.5 million in debt based solely on future rent. For reasons shown below, Judge Bentley concluded that “future payment obligations under its unexpired leases and executory contracts should rarely, if ever, be counted toward the subchapter V debt cap.”
Judge Bentley began his analysis by referencing the definition given by the Second Circuit to “noncontingent” and “liquidated” in Mazzeo v. United States (In re Mazzeo), 131 F.3d 295 (2d Cir. 1997). He quoted Mazzeo for saying that
“a debt is contingent if it does not become an obligation until the occurrence of a future event, but is noncontingent when all of the events giving rise to liability for the debt occurred prior to the debtor's filing for bankruptcy.” Id. at 303 (2d Cir. 1997).
Again citing Mazzeo, Judge Bentley said that a debt is liquidated if “the amount could be easily ascertained.” Id. at 304.
Judge Bentley said that Macedon used the same definitions to count post-petition rent, but he declined to reach the same result because “that decision overlooks the distinctive nature of a debtor’s obligations under its executory contracts and unexpired leases, which differ in key respects from other debtor obligations.”
As a matter of policy, Judge Bentley was disinclined to follow Macedon because “many debtors otherwise eligible for that subchapter are parties to long-term leases or contracts with future payment obligations well in excess of $7.5 million.”
Judge Bentley looked at executory contracts and unexpired leases from three points of view. If they are assumed, he said it’s “doubtful” whether the future obligations should even be considered “debts.”
If the debtor has neither assumed nor rejected, Judge Bentley said that “the amount and nature of its obligations under that contract or lease are contingent and unliquidated.”
If a lease or contract is rejected, Judge Bentley said, “it could be argued that the debtor’s rejection damages liability is a noncontingent debt as of [the filing date] for purposes of the subchapter V debt limit.” For example, he said there may be factual disputes about the amount of rejection damages.
Judge Bentley pointed to Parking Management, where he characterized Judge Catliota as holding that lease liability remains contingent until the court grants the debtor’s motion to reject.
Like Parking Management, Judge Bentley said that “the Debtor did not move to reject the Lease until after the petition date.” Therefore, he said that the “eventual liability under the Lease was contingent and unliquidated as of [the filing] date [and was] not properly counted toward the subchapter V debt cap.”
Another Approach
Courts may also wish to consider state law. Unless there has been a default and acceleration, some states would say that liability on a lease or a mortgage arises month to month. For instance, the statute of limitations begins to run every month when a lease or mortgage payment comes due. Thus, the statute may have run on payments due years earlier, but there can be new claims arising every month that are not time-barred.
Perhaps there is no debt to count toward the $7.5 million cap with regard to payments in the future where the statute has not begun to run.
Courts may also find guidance from Generally Accepted Accounting Principles (GAAP). To deal with a lease on a balance sheet, there is a short-term liability for payments due in 12 months and a long-term liability. There is also an asset called a “right of use asset,” which offsets the future liability on the lease. Thus, leases are disclosed on a balance sheet, but there is no net liability to depress the company’s net worth.
If GAAP doesn’t show future rent as a net liability, why should bankruptcy law?
Courts disagree on whether future liability on a lease counts toward the $7.5 million eligibility limit for Subchapter V.
Not counting future rent liability, Bankruptcy Judge Philip Bentley of New York disagreed with Bankruptcy Judge Klinette H. Kindred of Alexandria, Va., who knocked a debtor out of Subchapter V solely as a result of liability on a long-term lease. See In re Macedon Consulting Inc., 652 B.R. 480 (Bankr. E.D. Va. June 14, 2023).
Judge Bentley sided with Bankruptcy Judge Thomas J. Catliota of Greenbelt, Md., who held that contingent liability on a lease is not counted in deciding whether the debtor has more than $7.5 million in debt. See In re Parking Mgmt., 620 B.R. 544 (Bankr. D. Md. 2020).