Leases: To Be or Not to Be a Nonresidential Lease

In re Memory Lane of Bremen, LLC, 535 B. R. 901 (Bankr. N.D. Ga.) –

The chapter 11 debtors operated senior long-term care facilities on real property owned by a third party. The third party claimed that the debtors occupied the property under bona fide leases and sought (1) to compel the debtors to reject the leases and (2) relief from the automatic stay.

The debtors disputed that they were leasing the property, and instead contended that there was a partnership between the owner of the property and the principal of the debtors, with the owner supplying the real estate and cash for renovations and construction, while the debtors’ principal provided cash, personal property and business management expertise (including the ability to obtain necessary licenses).

Under Section 365(d)(3) of the Bankruptcy Code, a chapter 11 debtor in possession “must ‘timely perform all the obligations of the debtor’ during the time between the filing of the petition and the assumption or rejection of a nonresidential lease of real property.” Further, Section 365(d)(4) provides that a lease of nonresidential property by a debtor is deemed rejected if it is not assumed within the designated statutory period – generally 120 days. Otherwise, a debtor has until confirmation of the plan to make a decision.

The third party based its request for relief on the debtors’ failure to perform as required and the fact that its interest in the property was not adequately protected.

The court noted that the provisions requiring performance and setting a deadline for assumption or rejection applied only to nonresidential leases. It concluded that even if bona fide leases existed a lease to operate a long-term care facility was not a lease of “nonresidential real property” since people lived there. In support of its decision the court cited cases holding that leases of property by a debtor to operate senior nursing homes and low income rental housing were not nonresidential leases.

To the extent that the third party relied on compelling performance under Section 365(d)(3) or on a deemed rejection under Section 365(d)(4), the court could deny the requested relief without determining whether a bona fide lease existed since these sections were not applicable.

However, although a debtor would generally have until confirmation to determine whether to assume or reject a lease that was not subject to Section 365(d)(4), Section 365(d)(2) provides that a party to an unexpired lease may ask the court to order the debtor in possession to make a decision within a specified period of time. In determining whether to compel a decision, “a bankruptcy court should ensure that assumption or rejection occurs ‘within a ‘reasonable time,” with ‘[w]hat constitutes a reasonable time’ being ‘left to the bankruptcy court’s discretion in light of all relevant facts and circumstances.'”

The court did not believe it would be reasonable to compel the debtors to make a decision on assumption or rejection before there was a determination that a lease existed. Similarly, request for relief from the stay based on the debtors’ inability to assume the leases would be premature until it was determined that there was something to assume. The court was influenced in part by testimony that the value of the properties was he the remaining constant or increasing.

The debtors did announce that they intended to cease operations at one of the properties. Since they did not have any equity in the property, the court granted relief from the stay with respect to those premises. However, with respect to the other two premises, the court gave the debtors limited additional time to establish the nature of their rights.

Although the court did not require payment of rent as an obligation under a lease, it did exercise its discretion to require the debtors to put aside sufficient money on a monthly basis to cover payment of administrative rent to some entity (e.g. the purported landlord or the purported partnership) for postpetition use of the property.

It seems likely that the court was influenced by factors beyond those discussed in the opinion. In particular the court made a cryptic comment that the debtors “must address the concerns raised by the United States trustee’s recently filed a motion to dismiss the Debtors’ cases” without identifying the nature of the concerns. The court indicated that if the concerns were not addressed it would grant relief from the stay as to the remaining two properties on the basis that the properties were not necessary for an effective reorganization.

This case is a good reminder that some of the most frequently applied lease provisions in Section 365 are not generally applicable to all leases, but rather are limited to nonresidential real property leases.

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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