Leases: How About Those Attorneys’ Fees?

Leases: How About Those Attorneys’ Fees?

In re FKA FC, LLC, 545 B.R. 567 (Bankr. W.D. Mich. 2016)

A chapter 11 debtor sought to assume and assign a lease. The debtor contended that the cost to cure defaults under the lease was $0. The landlord objected arguing among other things that the cure costs should have included the attorneys’ fees it incurred as a result of the bankruptcy.

The debtor and its affiliates sold religious merchandise through retail stores throughout the country. In connection with a motion to sell substantially all of its assets, the debtor also sought to assume and assign unexpired leases, including the lease that was the subject of this decision.

Under the Bankruptcy Code a debtor must satisfy certain requirements as a condition of assuming a lease. This generally includes curing defaults (or providing adequate assurance of a prompt cure), including payment of amounts due. As explained by the court, a debtor tenant is permitted to continue leasing under favorable terms negotiated in better times. The quid pro quo is that the tenant must make the landlord whole and give it the benefit of its bargain. This requires the court to turn to state law to determine whether there has been a default and the landlord’s rights upon a default.

In this case the lease contained a typical default provision listing events that would constitute a default including:

(1) if Tenant fails to pay Rent, Security Deposit, or other money …, or

(2) if Tenant fails to perform or observe any agreement or condition on its part to be performed or observed, other than [certain defaults]… or

(3) if Tenant’s leasehold interest is levied on, attached or taken by any process of law, … or

(5) if any bankruptcy, insolvency or reorganization proceeding or arrangement with creditors (whether through court or by proposed composition with creditors) is commenced by or against Tenant.

With respect to money owed, the lease provided for base rent together with other charges, including common area maintenance (CAM) expenses and taxes. As is typical, the tenant was required to make monthly payments based on estimated CAM charges and taxes, and at the end of the year there was a reconciliation and adjustment of CAM expenses and taxes based on actual charges, with reconciling payments as applicable.

The landlord made several objections during the course of the litigation:

  • commencement of the bankruptcy constituted a default,
  • year-end tax and CAM adjustment payments constituted a default (and should be included in cure costs), and
  • there was a post-petition default based on a lien against the premises by a vendor that provided and installed an HVAC unit.

The court rejected each of these claims:

  • A breach based solely on commencement of a bankruptcy is unenforceable under Section 365 of the Bankruptcy Code as an “ipso facto” cause.
  • When the landlord gave notice of an increase in the estimated tax and CAM charges, the debtor promptly began paying the increased amounts, and the year-and adjustment was not yet due. (The court did note that the order approving the assumption and assignment of the lease specifically provided that the buyer was responsible for any obligations arising from the year-end adjustment.)
  • Although the HVAC vendor threatened to file a lien, it was never filed.

As an aside, it certainly did not help the landlord’s case that the first objection it filed recognized that there was no default.

Since the landlord was unable to establish that a default occurred, it lost its primary basis for claiming attorneys’ fees. Although the landlord still attempted to argue that it was entitled to fees based on terms in the lease, it did not adequately articulate its theories. In rejecting the landlord’s arguments, the court admonished that it was not sufficient to “mention a possible argument in the most skeletal way, leaving the court to … put flesh on its bones.”

The landlord also argued that it was entitled to attorneys’ fees based on a state statute that provided for recovery of fees in an action on a contract. In response the debtor reiterated that it was not in default and thus the landlord did not have a valid claim. Case law made it clear that a person must prevail on a claim for breach of contract and recover damages in order to be entitled to attorneys’ fees. The court agreed that without a default the landlord had no basis for recovering attorney’s fees under state law.

Consequently, the court approved the assumption and assignment of the lease and found that the cure costs were $0.

From a transactional attorney’s perspective it would be nice if one could come away from this case with a couple of lease drafting tips about how to avoid litigation like this in the future. However, this does not appear to be a problem of ambiguous drafting, but rather an illustration of the fact that pretty much anyone can sue if they have the money to pay for litigation.

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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