Assumption and Rejection

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”), which generally becomes effective and applies to bankruptcy cases filed after October 17, 2005, significantly impacts the rights of various parties in both consumer and business bankruptcy cases.  Among the entities affected by this legislation are landlords of commercial real property, who will now be able to determine their debtor-tenants’ intentions as to existing leases in a much quicker manner, and, therefore, spend less time litigating in the bankruptcy courts.

Currently, Section 365(d) of the Bankruptcy Code affords a debtor a period of 60 days from the date of a bankruptcy filing to assume or reject an unexpired lease of nonresidential real property.  If the lease is not assumed within that period, it is deemed rejected as a matter of law and the debtor is required to immediately surrender the property to the landlord.  This 60-day period, however, may be and typically is extended, over the landlord’s objection, through the confirmation of a plan of reorganization, which could take years.  As a result, commercial landlords remained hostage to a Chapter 11 debtor’s decision-making process to reject, assume, assign or even sell its right to assume and assign (referred to as “designation rights”) commercial leases. 

Pursuant to the Act, however, a commercial tenant debtor will now be afforded only a period of 120 days from the bankruptcy filing to assume or reject its lease, which period can only be extended for an additional 90 days by the court upon a showing of cause.  After that 210-day period, a debtor can obtain an additional extension only with the written consent of the landlord.  While seven months may still seem like a lengthy period to await the determination of a debtor’s rights under a lease, landlords who have been forced to accept multiple extensions of this deadline can attest that fixing a limit on the assumption/rejection period is a victory for the commercial real estate industry and a welcome balance of leverage in the bankruptcy “chess game.”  This time limitation imposed by the Act will also compel purchasers of designation rights, who frequently enjoyed a lengthy period of time in which to market the property to prospective assignees, to act with greater haste. 

This revision to Section 365(d) of the Bankruptcy Code may cause some debtors to prematurely assume their unexpired leases of commercial property, for fear that they will otherwise lose those valuable property interests by having them deemed rejected as a matter of law.  Prior to enactment of the Act, the assumption of an unexpired lease converted what would otherwise be a capped general unsecured claim (typically for one year’s worth of future rent due under the lease) into an administrative obligation of the bankruptcy estate for all rent due for the balance of the lease.  If a debtor later recognized the assumption was imprudent and sought to reject the assumed lease, the administrative obligation became a first priority obligation of the bankruptcy estate, superior to all other unsecured debts, pursuant to Section 503(b) of the Bankruptcy Code.  Congress, apparently recognizing the potentially deleterious effect of premature lease assumptions caused by revised Section 365(d), also amended Section 503(b) to provide that a landlord’s administrative claim resulting from the rejection of a previously assumed lease is limited to all monetary obligations due, excluding those arising from or relating to a failure to operate or a penalty provision, for the period of two years following the later of the date the lease is rejected and the date on which possession of the premises is surrendered.  This cap on a landlord’s administrative claim is subject to further reduction by any sums received or to be received by the landlord from an entity other than the debtor.  The balance of the landlord’s claim becomes a general unsecured claim. 

Shopping Centers

Another victory under the Act for commercial landlords – in particular, shopping center landlords – is contained in an amendment to the Bankruptcy Code that restricts the ability of debtor-tenants to ignore certain restrictions contained in shopping center leases when effectuating assignments of these leases.  Currently, Section 365(b)(3) of the Bankruptcy Code requires a debtor-tenant, when seeking to assign its interest in a shopping center lease to a third party, to provide “adequate assurance” that the proposed assignment will not, among other things, violate radius, location, use or exclusivity provisions of the lease, or disrupt any tenant mix or balance in the shopping center.  By contrast, Section 365(f)(1) of the Bankruptcy Code permits a debtor-tenant, when assigning its leasehold interest to a third party, to ignore a provision in a lease or applicable law that prohibits, restricts or conditions the assignment of a lease, with limited exceptions.  Some courts, utilizing Section 365(f)(1)’s prohibition against “anti-assignment” clauses in leases, have permitted debtor-tenants and their assignees to manipulate use and other restrictions in shopping center leases.  As a result, shopping center landlords, despite their best efforts to ensure adherence to a shopping center’s design, have often been at the mercy of debtor-tenants and bankruptcy courts.

Pursuant to the Act, however, Section 365(f)(1) has been amended and will not be applicable to assignments of shopping center leases under Section 365(b)(3).  As a result, shopping center landlords should find comfort in the closing of a “loophole” that allowed a debtor-tenant (or a holder of designation rights) to upset the integrity of the overall plan and composition of the shopping center.

Conclusion

The foregoing amendments to the Bankruptcy Code are certain to accelerate the time by which a commercial debtor-tenant decides to assume, reject or sell designation rights.  In fact, the imposition of time constraints might very well depress the market for “designation rights,” making it easier for landlords to “take back” their space.  Notwithstanding these landlord-friendly amendments, commercial landlords must be as vigilant as ever in opposing “creative” arguments regarding the use/sale of their space while continuing to enforce their existing rights under the Bankruptcy Code, including the right to be paid post-petition rent on a timely basis.