Rent as Administrative Expense: Can a “Terminated” Lease Also Be “Unexpired”?

Super Nova 330 LLC v. Gazes, 693 F.3d 138 (2d Cir. 2012)

In Super Nova the landlord obtained issuance of a warrant of eviction, but was not able to execute on the warrant prior to the bankruptcy filing.  The landlord eventually claimed post-petition rent, attorneys’ fees and interest for the period between the filing of the bankruptcy and execution of the warrant.  The bankruptcy court and district court rejected the claim.  The Second Circuit disagreed and remanded for further proceedings.

Super Nova was the landlord and Association of Graphic Communications, Inc. (AGC) was the tenant under a lease that was scheduled to expire on February 28, 2007.  AGC ceased business operations and stopped making rent payments sometime in 2006.  After demands for rent proved futile, the landlord began a nonpayment proceeding in November 2006.  It obtained a default judgment of possession and a warrant of eviction was issued on February 1, 2007.

Under the applicable New York statute:

The issuing of a warrant for the removal of a tenant cancels the agreement under which the person removed held the premises, and annuls the relation of landlord and tenant, but nothing contained herein shall deprive the court of the power to vacate such warrant for good cause shown prior to the execution thereof.

AGC filed a voluntary chapter 7 bankruptcy the day after the warrant issued (February 2, 2007,) with the result that the automatic stay prevented Super Nova from executing the warrant.  Super Nova subsequently obtained relief from the automatic stay and executed the warrant on April 24, 2007.

In January 2009, Super Nova moved for payment of unpaid rent, attorneys’ fees and prejudgment interest for the period between the date the petition was filed and the eviction date – arguing that under Section 365(d)(3) of the Bankruptcy Code, a trustee is required to timely perform obligations under any “unexpired” lease of non-residential property from the time the bankruptcy case commences until the lease is assumed or rejected.  The trustee opposed, arguing that since the lease was “terminated”, it was not “unexpired,” and thus was not subject to Section 365(d)(3).

State law determines the status of a lease.  In a prior case decided under Vermont law, the Second Circuit held that a terminated lease could nevertheless be “unexpired” for purposes of Section 365 if state law permits reinstatement.  In Vermont, until a landlord obtains a writ of possession, the debtor has a right to vacate the judgment of possession by curing the default on rent and payment interest and costs.  Under those circumstances, the Second Circuit held that a debtor that retains a possessory interest after issuance of the judgment of possession had an unexpired lease at least until the writ of possession was issued.  In a subsequent case, it held that upon issuance of the writ the debtor’s right to redeem was extinguished.

Distinguishing New York law from Vermont law, the court noted that AGC had a right to avoid eviction and reinstate the lease up until actual execution of the warrant of eviction (as opposed to being cut off upon issuance).  Since the automatic stay prevented execution of the warrant once the bankruptcy petition was filed, AGC’s right to reinstate the lease was preserved.  Thus, the lease was “unexpired” at the time the bankruptcy was filed because, although the warrant of execution had been issued, it had not yet been executed.

However, even if the lease was unexpired, the landlord was not necessarily entitled to rent and other costs.  In particular, Section 365(d)(3) requires performance of obligations under a lease until the lease is assumed or rejected.

A lease cannot be assumed if it has been terminated under state law.  Consequently, as of the beginning of the bankruptcy case, the trustee could only have rejected the lease, not assumed or assigned it.  This suggests that an unexpired but terminated lease should be presumed rejected, as opposed to requiring an affirmative rejection.

On the other hand, the court noted the trustee could have moved post-petition to first reinstate the lease, and then assume it.  Further, pending the action the trustee remained in legal possession of the property.  To avoid allowing the trustee to have his cake and eat it too, it would be reasonable to require an affirmative rejection.  (Alternatively, under Section 365(d)(4) of the Bankruptcy Code if a trustee does not assume a nonresidential lease in a chapter 7 liquidation proceeding, the lease is deemed rejected 120 days after commencement of the case.)

Since the question of whether the trustee was required to affirmatively reject the lease was not briefed or argued in the lower courts, the Second Circuit elected to remand for a decision by the bankruptcy court.  The court further directed the bankruptcy court to reconsider its finding that the trustee was not in possession in the event that was relevant to determining whether the landlord was entitled to an administrative claim.

By the time the bankruptcy commenced AGC had ceased operations in the premises (although apparently it left behind some personal property and debris that the landlord contended cost $10,000 to remove); a warrant of eviction issued which had the effect of terminating the lease, and the trustee did not oppose lifting the stay so that the landlord could execute the warrant of eviction.  Under these circumstances, the trustee could reasonably expect that there would be no obligation to pay post-petition rent.  However, if the case is before a court that applies the Second Circuit’s reasoning, as long as there is a theoretical possibility of reinstating the lease, it may be necessary to take action to affirmatively reject the lease immediately after the bankruptcy is filed in order to avoid the potential claim for rent.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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