Landlord and Tenant Clashes in Subchapter V: Unexpired Lease Obligations Affecting Eligibility to Elect Subchapter V Treatment

Since its inception, subchapter V of chapter 11 has been lauded for providing a streamlined path through chapter 11 for smaller chapter 11 debtors without many of the costs associated with “traditional” chapter 11 cases. But before a debtor can elect subchapter V treatment and take advantage of these benefits, the debtor must have less than $7.5 million in total noncontingent, liquidated debts (both secured and unsecured).

For debtors who are tenants under unexpired leases, understanding what does — and doesn’t — count toward this $7.5 million threshold has become the subject of disagreement between landlords and tenants, and courts are falling on both sides of the debate. At issue is the question of whether future lease liabilities should be included as part of a debtor’s subchapter V eligibility calculation. Should they be treated as noncontingent, liquidated debts despite a debtor’s ability to reject the lease in bankruptcy, making it harder for debtors to meet the threshold? Or should they be treated as contingent, unliquidated amounts and therefore not included as qualifying debts for subchapter V?

Two recent bankruptcy court decisions have given rise to a split of authority regarding how courts will determine a chapter 11 debtor-tenant’s eligibility to elect subchapter V treatment, based on their outstanding unpaid lease obligations at the time of filing. In In re Macedon Consulting Inc.,[1] the U.S. Bankruptcy Court for the Eastern District of Virginia held that all of a debtor’s future liability under an unexpired lease is considered noncontingent, liquidated debts subject to the subchapter V eligibility requirements of § 1182 of the Bankruptcy Code. The Macedon debtor was a tenant under a long-term lease with its landlord that had nearly $14.4 million in future lease payment liabilities when the debtor filed for bankruptcy protection.

When the debtor filed its bankruptcy petition and elected subchapter V treatment, it simultaneously filed a motion seeking to reject the lease, arguing that the rejection (effective as of the debtor’s bankruptcy filing date) extinguished the debtor’s future liability under the lease, therefore future rent amounts could not be counted as qualifying debts when calculating its subchapter V eligibility. The court concluded that the Macedon debtor’s full future liability under its lease controlled the analysis, rather than the Bankruptcy Code’s formula for determining “rejection damages” for a lease that is rejected prior to the conclusion of its term, which in many cases acts as a cap on the total liability a debtor has to its landlord.

In In re Zhang Medical P.C.,[2] the U.S. Bankruptcy Court for the Southern District of New York responded directly to the Macedon decision, reaching the opposite conclusion on this issue (despite finding that the Debtor did not qualify for Subchapter V on other grounds), holding that a debtor’s future payment obligations under an unexpired lease should rarely, if ever, be counted toward the subchapter V debt threshold “because of the enormous — and in the Court’s view detrimental — impact that ruling, if followed, would have in limiting eligibility for subchapter V relief.”

This split in authority makes clear that the law is far from settled with respect to electing subchapter V treatment, and practitioners should take careful note when assessing a debtors’ eligibility for subchapter V.