A Chapter 7 trustee sought to assume a debtor’s rent-stabilized lease so that he could sell it to the owner of the building. In response, the debtor amended her bankruptcy exemption schedule and claimed the value of the rent-stabilized lease as exempt from the bankruptcy estate as a right to receive a “local public assistance benefit” as contemplated by state law.
The bankruptcy court ruled that the lease was not exempt as a local public assistance benefit. The district court affirmed, and the debtor appealed to the Second Circuit.
The debtor had lived in a rent controlled apartment in Manhattan for over 40 years. She experienced financial difficulty after her husband died and filed a Chapter 7 bankruptcy. Originally she only listed the lease in her bankruptcy schedules as an “unexpired lease” under Schedule G (executory contracts and leases).
The Chapter 7 trustee initially concluded that this was a no-asset case. However, the landlord offered to buy the lease under terms that would allow the debtor to stay, but would cause the apartment to lose its rent stabilized status. When the debtor learned that the trustee intended to accept the landlord’s offer, she amended her schedules to claim the lease as an exempt asset.
The trustee objected, arguing that a rent stabilized lease was just a “quirk of the regulatory scheme in the New York housing market.” In affirming the bankruptcy court decision, the district court agreed that the lease was “‘the collateral consequence of a regulatory scheme’ rather than a local public assistance benefit.”
The Second Circuit determined that the state courts had not yet addressed this question. Since the issue was a matter of “significant public importance,” it certified the following question to the New York Court of Appeals:
Whether a debtor-tenant possesses a property interest in the protected value of a rent-stabilized lease that may be exempted from her bankruptcy estate pursuant to New York State Debtor and Creditor Law Section 282(2) as a “local public assistance benefit”?
The state court responded:
When the rent-stabilization regulatory scheme is considered against the backdrop of the crucial role that it plays in the lives of New York residents, and the purpose and effect of the program, it is evident that a tenant’s rights under a rent-stabilized lease are a local public assistance benefit.
The state court specifically rejected the trustee’s argument that “benefits” meant cash payments. The state court also noted that its interpretation was consistent with the purpose of the state law to protect essential needs, including housing.
Given the response to the certified question, the Second Circuit reversed the lower court decisions and held that the debtor was allowed to exempt her rent-stabilized lease as a local public assistance benefit.
A discussion by New York practitioners highlighted the impact of this decision on evaluating the option of bankruptcy for a client. Prior to this case, there was a general expectation that rent stabilized leases would not be exempt assets. So if a debtor had a low rent lease in a desirable location, this fact could weigh heavily against filing a Chapter 7 bankruptcy since there was a risk that the Chapter 7 trustee would sell the lease to the landlord (who would have an interest in being able to return the property to a market rate apartment). This decision substantially alters that analysis.
The case provides an interesting perspective on rent control. As one person noted, wealthy New Yorkers living in rent-stabilized apartments might be surprised to learn that they are receiving public assistance.
Vicki R. Harding, Esq.