Lease Claims: Sometimes Privity Matters

In re Parrott Broadcasting Ltd. P’ship, 492 B.R. 35 (Bankr. D. Idaho 2013) –

A chapter 7 trustee objected to a proof of claim filed by a landlord for rent and late charges due under a lease.  The debtor was an assignee of the tenant, but was not a party to the lease, and the landlord did not consent to the assignment.   Under the circumstances, the bankruptcy court disallowed the landlord’s claims.

Hilo Broadcasting (Hilo) held a license for a radio station and owned a transmission tower located on property of the landlord (Kani).  A lease agreement between Hilo and Kani gave Hilo the right to use a portion of the property for the tower for radio broadcasting purposes.  The lease prohibited assignment of the agreement or any part of Hilo’s interest in the agreement.

The debtor (Parrott) acquired the radio station assets, including the tower, from Hilo.  A post-closing agreement between the parties provided that the debtor would assume and accept assignment of Hilo’s rights and duties under the lease notwithstanding the prohibition on assignment.  The parties agreed that Hilo would retain the lease in its name, but that the debtor would have all of the benefits under the lease, specifically including access to the tower site.

Kani filed an amended proof of claim in Parrott’s bankruptcy asserting that ~$44,000 was due for post-petition rent and late charges (~$19,900 for rent and ~$23,800 for late charges).  Under the Bankruptcy Code and rules, a timely filed proof of claim is deemed allowed, unless a party objects, and is prima facie evidence of the validity and amount of the claim.  If an objection is made (as was the case here), the court must make a determination, with the burden on the objector to overcome the prima facie validity of the claim.

As an initial procedural matter, the response to the trustee’s objection was filed by Kani’s president (who was not a lawyer).  Although an officer of a corporation may file a proof of claim on behalf of the entity, the court agreed with the trustee that a corporation must be represented by counsel in filing a pleading or appearing in a case.  (The court also noted that the amended proof of claim listed the president, as opposed to Kani, as the creditor.  However, there was no evidence that the claim had actually been transferred by Kani to its president in compliance with the bankruptcy rules.  So, the court continued to treat the claim as held by Kani.)

The court concluded that it could strike Kani’s response to the trustee’s objections since it was not filed by an attorney.  However, since Kani could ask for reconsideration once it was represented by counsel, in the interests of expediency the court also addressed the merits of the issues.

Although the purchase agreement between the debtor and Hilo required Hilo to obtain third party consents for assignment of contracts, the post-closing agreement recited that it was “impractical to obtain an assignment” of the lease.  The court speculated that Kani either refused to give consent or was never asked to do so.

The agreement between Hilo and the debtor included several provisions intended to isolate the debtor from the landlord, including (1) requiring the debtor to make payments to Hilo, who in turn would remit them to Kani, and (2) requiring that all communications with Kani be conducted exclusively by Hilo.

Regardless, the landlord eventually became aware of their agreement, since it sought to use the debtor’s assignment/assumption agreement with Hilo as part of the basis for its lease claim.  However, while acknowledging that there was no doubt that the debtor was liable to Hilo for its obligations as tenant under the lease agreement, the court concluded that the debtor did not have any direct liability to the landlord: Hilo was expressly prohibited from assigning the lease without consent; Kani did not consent; so no privity of contract existed between Kani and the debtor.

In addition, Section 365(d)(4) of the Bankruptcy Code provides that a non-residential real property lease is deemed rejected if it is not assumed within 120 days after the petition date (subject to certain extensions and adjustments).  According to the court, rejection constitutes a breach immediately prior to the bankruptcy, and the unexpired lease is removed from the bankruptcy estate.  In this case the debtor clearly did not assume the lease with Kani.  (Although the case stated as a chapter 11 reorganization, and was converted to a chapter 7 liquidation more than a year later, the conversion does not restart the clock.)

The amended proof of claim included only post-petition rent and late charges.  While acknowledging that if the debtor had been liable under the lease the landlord might have been entitled to a pre-petition claim based on unpaid rent for the remainder of the lease term, the landlord was not entitled recover post-petition rent or late charges based on the lease because the lease was not assumed.

The court made a qualifying comment that if the debtor had been obligated to perform under the lease, the rent obligation would have continued during the first 60 days of the case, and the landlord would have been entitled to an administrative expense claim for that period.  However, Kani did not timely file an administrative claim, so would not be entitled to assert a claim for this period in any event.

Thus, the court concluded that the claim should be disallowed for several reasons:  (1) by default, since the president could not respond on Kani’s behalf to the trustee’s objection to its proof of claim, (2) the debtor did not have an enforceable obligation to make lease payments to the landlord based on the lack of privity, and (3) even if the landlord could assert a claim against the debtor under the lease, claims for post-petition rent and late charges were improper absent assumption of the lease during the bankruptcy case.

This case suggests that (a) it may not be in a landlord’s best interests to simply ignore a lease assignment that is not in compliance with the terms of the lease, and (b) a landlord may want to try to take affirmative action to protect its interests if an assignee files bankruptcy while in possession of the leased premises but without clear liability to the landlord for obligations under the lease.

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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