Bankruptcy Judge James L. Garrity, Jr., of New York described the factors that control whether the court may reject a real property release retroactively to the petition date when the lease had not been terminated under state law before filing. Basically, the court balances the equities.
The debtor signed a 25-year lease for commercial property in 2002. The debtor closed the business in 2016 but signed up a subtenant with the landlord’s consent. The subtenant stopped paying rent during the pandemic.
The debtor sued the subtenant and eventually negotiated a settlement in August 2021 calling for the subtenant to pay the debtor about $3 million. The settlement terminated the sublease and returned possession to the debtor.
Meanwhile, the landlord had been suing the debtor in state court and won a summary judgment motion in September 2021 giving the landlord a judgment for some $1.2 million representing unpaid rent.
In late August 2021, after the settlement where the subtenant surrendered possession of the premises, the debtor surrendered the keys to the landlord, but the landlord returned the keys and refused to accept possession of the premises.
Two weeks later, the debtor filed a chapter 11 petition and simultaneously filed a motion to reject the lease. The debtor confirmed a Subchapter V plan seven months after filing.
In his opinion on December 22, Judge Garrity dealt with the motion to reject, the debtor’s request to make rejection effective retroactively as of the petition date, and the cap on lease-rejection damages.
The debtor contended that rejection was unnecessary because the lease terminated before bankruptcy when the debtor attempted to surrender the premises.
Judge Garrity said that he would “look to state law to determine whether a lease has been terminated prepetition.” Consulting the lease, he observed that the debtor had no unilateral right of termination, a right given exclusively to the landlord.
Judge Garrity held that the lease had not been terminated before filing, but he gave credit to the debtor’s business judgment and approved rejection of the lease under Section 365(a).
Next, Judge Garrity tackled the question of retroactivity to the filing date. He said that “a bankruptcy court may grant a motion to reject an executory contract nunc pro tunc to a date before which a party against whom relief is sought can file an objection” when “‘the equities [so] demand.’” [Citations omitted.]
According to Judge Garrity, the equities include the landlord’s failure to mitigate damages and the debtor’s decision to vacate the premises. He said that the “equities may favor retroactive rejection . . . where the premises have been clearly surrendered, and where landlord has been given notice through the filing of the rejection motion such that the landlord can prepare for the rejection and begin to mitigate its losses.”
The equities favored the debtor. Judge Garrity said that “the Landlord’s inaction in the face of the Debtor’s attempted surrender of the Premises and its awareness that the Court might rule against it supports retroactive relief.”
In opposition, the landlord cited state law that says that a landlord has no duty to mitigate, but Judge Garrity cited the Second Circuit for saying that “equity’s concerns are broader than the law’s requirements.”
Finding that the equities favored the debtor, Judge Garrity authorized rejection retroactively as of the petition date.
Next, Judge Garrity turned to the calculation of rejection damages under Section 502(b)(6). Both sides agreed that the rejection claim should be capped at one year, but they disagreed about when the one-year period should begin.
The landlord wanted the year to begin on the filing date, but the debtor contended that the date of attempted surrender was proper.
Although an attempted surrender won’t terminate the lease before bankruptcy, Judge Garrity cited authorities for the idea that attempted surrender does “bear on the calculation of the statutory cap for damages as a result of lease rejection.” The authorities, he said, “require that a court begin the section 502 calculation on the earlier of the petition date or the date on which the lessee attempted to surrender the premises.”
We will not burden our readers with a recantation of the calculation of damages, but suffice it to say that Judge Garrity granted the motion to reject and calculated the one-year cap as beginning on the date of the attempted surrender.
Bankruptcy Judge James L. Garrity, Jr., of New York described the factors that control whether the court may reject a real property release retroactively to the petition date when the lease had not been terminated under state law before filing. Basically, the court balances the equities.
The debtor signed a 25-year lease for commercial property in 2002. The debtor closed the business in 2016 but signed up a subtenant with the landlord’s consent. The subtenant stopped paying rent during the pandemic.
The debtor sued the subtenant and eventually negotiated a settlement in August 2021 calling for the subtenant to pay the debtor about $3 million. The settlement terminated the sublease and returned possession to the debtor.
Meanwhile, the landlord had been suing the debtor in state court and won a summary judgment motion in September 2021 giving the landlord a judgment for some $1.2 million representing unpaid rent.