Delaware Business Bankruptcy Report : Delaware Business Bankruptcy Report : Morris James LLP Lawyers & Attorneys

The debtor rejected a lease of non-residential real property, and the landlord filed its rejection damages claim. Thereafter, the landlord sold the premises. The trust for the debtor’s estate objected to the claim. The Court sustained the objection in part, finding that when the landlord sold the premises, it exercised full dominion, eliminating any claim it had against the debtor for rent arising after the sale of the premises.

Movant Loudoun Gateway III, LLC was a landlord to the debtor, FLYi, Inc., under a prepetition lease of non-residential real property located in the state of Virginia. The debtor rejected the lease after its bankruptcy filing, and Loudoun filed a rejection damages claim for $2,324,342.16.

The trust created to liquidate the estate and reconcile claims objected to the rejection damages claim on the basis that Loudoun sold the leased premises, thereby eliminating its claims to unpaid rent and other rejection damages arising after the sale of the premises.

The trust asserted that under the lease and Virginia state law, Loudoun had three options upon the rejection of the Lease: (i) do nothing and sue for the rent remaining under the lease; (ii) reenter the premises for the sole purpose of re-letting it without terminating the lease; or (iii) re-enter the premises and exercise full dominion over the premises, thereby terminating the lease and eliminating the debtor’s obligation to pay any future rent. The trustee asserted that by selling, Loudoun exercised full dominion over the premises, and therefore eliminated any obligation to pay rent after the sale of the premises. Loudoun asserted that the sale did not constitute an acceptance of the debtor’s surrender of the premises and was not a lease termination. In support of its position, Loudoun contended that In re Ames Dept. Stores, Inc., 173 B.R. 80 (Bankr. S.D.N.Y. 1994) was directly on point.

The Court agreed with the trust’s characterization of Virginia law, and found that Loudoun exercised the option of exercising full dominion over the premises and eliminating any future rent obligation. In so doing, the Court expressly rejected the Ames holding, finding that it was based on an incomplete analysis of common law. The Ames court found that, under Maryland law, when a tenant breaches a lease, the landlord is entitled to damages in an amount equaling the outstanding rent for the remaining term of the lease.   Here, the Bankruptcy Court held that Ames failed to account for the consequences under common law of the landlord’s sale of the premises, i.e., the surrender of any right to collect rent for the remaining term from the breaching tenant.

Loudoun also argued that even if Virginia common law precluded a selling landlord from collecting rent from the breaching tenant, the lease between the parties contracted around that result. Specifically, the lease contained a clause that provided that, on termination, nothing in the lease prejudiced the landlord’s right to obtain “an amount equal to the maximum allowed by any statute or rule of law in effect at the time when such termination takes place . . .” The Court determined, however, that this provision only said that nothing reduced the rights that Loudoun had under state law. However, it did not expand Loudoun’s rights either.

Loudoun also contended that the lease contained an acceleration clause that supported its claim for all future rent arising after rejection. The clause provided that “upon the occurrence of an Event of Default by Tenant under the terms of this Lease, rent which otherwise would be due or would have been due except for any abatement provided for in this Lease . . . shall be immediately due and payable.” The Court held this was not an acceleration clause, but instead found that this clause only permitted Loudoun to collect any past rent that was abated if the debtor breached the lease.

Finally, the lease contained another provision that Loudoun argued preserved its right to a claim for all future rent. It provided that, in the event of a bankruptcy, the debtor was required to assume or reject within sixty (60) days or the lease would be deemed rejected. Then, “[after rejection of the lease], Landlord shall be entitled to possession of the Premises without further obligation to Tenant or the Trustee, and this Lease shall be cancelled, but Landlord’s right to be compensated for damages in such liquidation proceeding shall survive.” The Court found that this did not create a specific damages claim, but instead only limited the time for the debtor to assume or reject the lease. Moreover, the Court found that this clause would be unenforceable as an ispso facto clause if Loudoun’s interpretation of the clause’s meaning was correct.

Consequently, the Court concluded that any claim for rejection damages arising after the sale of the premises was lost, and the landlord’s damages were limited to any amounts arising prior to the sale.

UPDATE: For an excellent analysis of the implications of this opinion, we suggest you visit In the (Red), the bankruptcy blog of Bob Eisenbach of Cooley Godward Kronish LLP.