Deemed Lease Rejection: Nothing Says That the Bankruptcy Code Must Make Sense

In re Hyegu Cho, 550 B.R. 152 (Bankr. D. Me. 2016)

A landlord moved for relief from the automatic stay in a chapter 13 case. It contended that the lease was a commercial lease that was deemed rejected because the deadline for assuming the lease had passed. The debtor argued that the applicable provision in section 365 of the Bankruptcy Code did not apply in a chapter 13 case.

The debtor had a dry cleaning business. He leased the business premises under a 10 year lease that he executed in his own name. When the debtor and his wife filed a chapter 13 bankruptcy (for adjustment of debts of individuals), they did not include the lease in their bankruptcy schedules, and their initial chapter 13 plan did not make any provision for the lease, although the statement of business income and expenses reflected $3,000/month rent for the dry cleaning business.

They also did not schedule the landlord as a creditor, nor did they assume the lease within 120 days after the bankruptcy was filed. So, the landlord filed a motion for relief from the automatic stay and to force surrender of the property. The next day the debtors filed an amended plan that proposed to assume the obligations under the lease.

Section 1322(b)(7) provides that a chapter 13 plan may “subject to section 365 of this title, provide for the assumption, rejection, or assignment of any executory contract or unexpired lease of the debtor not previously rejected under such section” (emphasis added). And section 365(d)(4)(A) provides (emphasis added):

[A]n unexpired lease of nonresidential real property under which the debtor is the lessee shall be deemed rejected, and the trustee shall immediately surrender that nonresidential real property to the lessor, if the trustee does not assume or reject the unexpired lease by the earlier of –

(i) the date that is 120 days after the date of the order for relief; or
(ii) the date of the entry of an order confirming a plan.

The court noted that there was merit to the debtors’ argument that this provision should not apply in a chapter 13 bankruptcy. This issue typically arises in a chapter 11 reorganization case. In that context: in the few cases where a trustee is appointed, the trustee has the power to operate the debtor’s business under section 1108, and under section 1107 the debtor is a “debtor in possession” entitled to exercise powers of a trustee, including assumption or rejection of leases.

In contrast, a chapter 13 trustee has only a limited role to play, which does not include operating the debtor’s business, and a chapter 13 debtor is not given the power to exercise any of the functions of a trustee. So, neither the trustee nor the debtor is in a position to assume or reject a lease. Notwithstanding this conundrum, a majority of courts hold that section 365 does apply in a chapter 13 case, and thus a commercial lease must be assumed within the stated time or it will be deemed rejected.

The court identified three potential interpretations of section 365(d)(4)(A):

  • Section 365(d)(4)(A) does not apply in a chapter 13 bankruptcy.
  • Although this subsection refers to assumption or rejection by a trustee, the statute should be read to allow the debtor to do so.
  • The statute means what it says (I.e. the trustee must be the one to assume) “even if that interpretations does not make sense.”

The court rejected the first interpretation since this subsection was not limited in scope, unlike other subsections (such as section 365(d)(2), which applies to all cases except those under chapter 7). As to the remaining two arguments, the court did not find either to be “entirely satisfactory,” but did not have to decide since neither the trustee nor the debtor moved to assume the lease in a timely manner, and thus the lease was deemed rejected.

The debtor attempted to argue on an equitable basis that the lease should not be deemed rejected – the failure to deal with the lease may have been due to a language barrier or confusion about whether the debtor himself was a party to the lease as opposed to the business. The court rejected these arguments and held that the Bankruptcy Code does not give a court the general power to create substantive rights contrary to specific provisions.

Consequently the court granted the landlord’s request for relief from the stay, although it did not compel the debtor to surrender the property (since the subsection provides that the trustee, as opposed to the debtor, is required to surrender the premises).

Sometimes nuances in the Bankruptcy Code are easy to overlook or forget. There are a number of cases dealing with timing and the deemed rejection of leases. It is important to remember that this subsection deals only with nonresidential leases. Similarly chapter 11 debtors routinely exercise rights of a trustee, such as avoiding powers. What often goes unsaid is that this is based on section 1107. There is a similar section applicable to family farmers in chapter 12 cases (section 1203), but no comparable provision for chapter 13 debtors.

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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