Presenting a live 90 minute webinar with interactive Q&A. Td Today s faculty features:

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1 Presenting a live 90 minute webinar with interactive Q&A Tenant Bankruptcy: Assumption and Rejection of Commercial Leases Strategies for Landlords and Tenants to Protect Their Interests Under the Bankruptcy Code THURSDAY, MARCH 10, pm Eastern 12pm Central 11am Mountain 10am Pacific Td Today s faculty features: Jason B. Binford, Attorney, Kane Russell Coleman & Logan, Dallas Gary M. Kaplan, Special Counsel, Farella Braun + Martel, San Francisco Robert L. LeHane, Partner, Kelley Drye, New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 March 3, 2011 Tenant Bankruptcy: Assumption and Rejection of Commercial Leases GARY M. KAPLAN, Farella Braun + Martel LLP

6 Bankruptcy Lease Basics Bankruptcy Code 365 governs debtor s assumption, rejection and assignment of unexpired commercial leases Assumption = Ratification of lease Rejection = Anticipatory i t repudiation of lease 365(d)(3) addresses tenant s obligations under lease pending assumption, rejection or assignment 6

7 Lease Obligations Pending Assumption/Rejection 365(d)(3) requires debtor-tenant to timely perform its postpetition (i.e., e post-bankruptcy) obligations until it is assumed, rejected or assigned Court may extend time for performing obligations arising i within 60 days after bankruptcy filing, but not past 60 th day Unpaid obligations give rise to administrative claim with priority over general unsecured claims Claim generally = amount provided in lease, regardless of actual value to bankruptcy estate. E.g., In re Cukierman, 265 F.3d 846 (9th Cir. 2001) 7

8 Administrative Expense Claim for Unpaid Postpetition Lease Obligations Courts split regarding debtor s obligation to immediately pay post-petition petition lease obligations under 365(d)(3) if debtor lacks funds to pay all other administrative expenses Most courts: No super-priority ; postpetition lease obligations should not be paid unless sufficient funds to fully pay all administrative claims. Many courts: 365(d)(3) obligations = super-priority administrative claim; must be timely paid regardless of debtor s ability to pay other administrative claims Other courts: Current payment of 365(d)(3) obligations required, subject to later disgorgement if insufficient funds to pay all administrative claims; pro rata distribution 8

9 Scope of Debtor s Postpetition Lease Obligations under 365(d)(3) 365(d)(3) generally encompasses obligations for taxes, insurance, CAM, utilities, repairs, clean-up costs, late charges, interest and other monetary obligations. E.g., In re Cukierman, 265 F.3d 846 (9th Cir. 2001); In re National Refractors & Minerals Corp., 297 B.R. 614 (Bankr. N.D. Cal. 2003); In re Far West Corp. of Shasta County, 120 B.R. 551 (Bankr. E.D. Cal. 1991) Some courts - failure to comply with obligation to restore premises upon lease rejection does not give rise to administrative priority claim. E.g., In re TreeSource Industries, Inc. 363 F.3d. 994 (9th Cir. 2004) 9

10 Obligation to pay landlord attorney fees Most courts: Debtor required to pay landlord s postpetition attorney s feesinenforcing 365(d)(3) enforcing obligations (if allowed under lease), but some courts hold to contrary In re Midway Airlines Group, 406 F.3d 229 (4th Cir. 2005); ( 365(d)(3) obligations include attorneys fees in enforcing lease) In re Pacific Arts Publishing, Inc., 198 B.R. 319 (Bankr. C.D. Cal. 1996) (attorneys fees incurred in enforcing lease are not included in 365(d)(3) obligations) 10

11 Exclusions to 365(d)(3) Lease Obligation Performance Certain lease obligations (listed in 365(b)(2)) excluded d from 365(d)(3) performance obligations Penalty rates, provisions arising from debtor s failure to perform non-monetary obligations Ipso facto provisions (imposing obligations or penalties based on filing of bankruptcy case, financial condition of debtor or appointment of bankruptcy trustee or custodian prior to bankruptcy) 11

12 Stub Rent and Proration Courts split on debtor s 365(d)(3) obligations where portion of obligation falling due postpetition accrued prepetition Many courts use billing date approach: Obligations due postpetition including amounts accrued prepetition must be paid under 365(d)(3) without proration; debtor need not pay rent for postpetition occupancy if payment due prepetition. E.g., In re Montgomery Ward Holding Corp., 268 F.3d 205 (3d Cir. 2001); In re Koenig Sporting Goods, Inc., 203 F.3d 986 (6th Cir. 2000); Ha-Lo Industries, Inc. v.. Centerpoint Properties Trust, 342 F.3d 794 (7 th Cir. 2003); In re Burival, 613 F.3d 810 (8th Cir. 2010) 12

13 Stub Rent and Proration Substantial number of courts: Debtor must pay prorated amount where obligations due postpetition include amounts accrued prepetition E.g., In re Handy Andy Home Improvement Centers, Inc., 144 F.3d 1125 (7th Cir. 1998); In re Furr s Supermarkets, Inc., 283 B.R. 60 (B.A.P. 10th Cir. 2002) Some courts require prorated payment of lease obligations accruing postpetition even where payment due prepetition. (E.g., In re Victory Markets, Inc., 196BR B.R. 6(NDNY (N.D.N.Y. 1996)) 13

14 Stub Rent and Proration Alternatively, courts require prorated rent payment for postpetition period where payment due prepetition under Bankruptcy Code 503(b)(1) based on actual value of property to bankruptcy estate (E.g., In re Goody s Family Clothing, Inc., 610 F.3d 812 (3rd Cir. 2010), cert. den., U.S., 131 S.Ct. 662, 178 L.Ed.2d 483 (2010)) 14

15 Related Publications By Gary M. Kaplan Lessor Update: What Commercial Landlords Need to Understand About Bankruptcy (The Americas Restructuring and Insolvency Guide 2008/2009; Cal. State Bar Business Law News, Issue No. 1, 2009) Bankruptcy Primer For Commercial Landlords (International Legal News, 2009; Cal. Real Estate Journal, 2009) 15

16 Contact Information Gary Kaplan Special Counsel, and Co-Chair of Restructuring, Insolvency & Creditors Rights Group Farella Braun + Martel LLP 235 Montgomery Street, 17 th Floor San Francisco, CA gkaplan@fbm.com

17 Commercial Leases in Bankruptcy Deadlines to Assume or Reject and Calculating Rejection Damages by Robert L. LeHane March 10, 2011

18 Overview Deadlines for assumption and rejection General statutory scheme under section 502(b)(6) Components of rent reserved under the lease Mechanics of the calculation, including money model versus time model Capped claim versus actual damages; mitigation Rejection damages issues: rent concessions, setoffs, security deposits, letters of credit Rejection following an assumption 18

19 Deadlines for Assumption and Rejection 19

20 Deadlines for Assumption and Rejection Section 365(d)(4): the debtor must reject, assume, or assign its leases within a maximum of 210 days after filing for bankruptcy, unless the lessor consents to allow the debtor more time Initial period of 120 days to decide After 120 days, the bankruptcy court is limited to granting one 90-day extension for cause ( 365(d)(4)(B)(i)) Subsequent extensions may only be granted with the written consent of the lessor ( 365(d)(4)(B)(ii)) 20

21 Deadlines for Assumption and Rejection: Debtor s Request for Extension First extension (90 days) Routinely granted by courts (e.g., A&P, Blockbuster Video) Objecting landlord needs to show significant prejudice to deny extension more than just debtor s failure to pay rent Second and subsequent extensions Lessor requests in consideration for written consent Stub rent Preference waiver Accrued but unbilled charges (e.g., taxes) Increased frequency of payment on CAM, tax, or insurance charges notwithstanding lease terms Attorneys fees, non-monetary Cash 21

22 Calculating Lease Rejection Damages and the 502(b)(6) Cap 22

23 Damages under a rejected lease: General Unsecured Claim Section 502(b)(6) caps damages under a rejected lease of nonresidential real property: Unpaid pre-petition obligations; plus The rent reserved under the lease for the greater of (i) one year or (ii) 15% of the remaining term of the lease, not to exceed three years, following the earlier of the petition date or the date the premises are surrendered Congressional Intent: prevent claims under rejected long-term real property leases from swamping unsecured class 23

24 Unpaid pre-petition petition obligations All prepetition arrears may be claimed as part of the general unsecured claim not capped In billing date jurisdictions (3d Cir. Delaware) certain charges may be administrative obligations instead of prepetition arrears: See Centerpoint Holdings v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 268 F.3d 205 (3d Cir. 2001) Ex: 2011 real estate taxes are due quarterly in arrears (Q1 taxes due 6/30/11; Q2 taxes due 9/30/11; Q3 taxes due 12/31/11, etc.). Debtor files bankruptcy on April 15, Pro-Ration Theory Q1 taxes would be included as a prepetition arrearage as part of the general unsecured claim. Billing Date Theory Q1 taxes would be an administrative obligation 24

25 Rent Reserved Under the Lease: Components of the 502(b)(6) Calculation 25

26 Rent Reserved Under the Lease Rent reserved under the lease is that which is: Fixed Recurring Related to the value of the leasehold 26

27 What is rent reserved under the lease? Generally included: Base rent Common area maintenance Real estate taxes Insurance Utilities (if fixed amount, and paid to landlord and not directly to utility) Generally NOT included: Attorneys fees Repair costs Reletting costs Broker fees Late charges 27

28 The Mechanics of the Calculation 28

29 The mechanics of the 502(b)(6) calculation Common mistake: Calculating 502(b)(6) damages from the effective date of rejection. Per the statute, usually perform calculation based on rent reserved under the lease from the petition date Use surrender date if surrender under state law occurred prepetition Calculating from petition date does not double count administrative rent paid because 502(b)(6) ) is a statutory construct; any post-petition rent collected by landlord reduces actual damages Actual damages are determined by reference to applicable state law and are typically measured from the effective date of rejection 29

30 The mechanics of the 502(b)(6) calculation One year or fifteen percent? Based on remaining term of lease as of petition date If Cap will be 12 to 80 months remain One year (or actual damages) 80 to 240 months remain 15% More than 240 months Less than 12 months Three years Actual damages 30

31 The mechanics of the 502(b)(6) calculation: money model versus time model Money Model 15% calculation Calculate rent over the entire term of the lease as of petition date, and multiply by Usually results in higher capped claim because it gives effect to periodic late term rent escalations Majority view (see In re Andover Togs, Inc., 231 B.R. 521 (Bankr. S.D.N.Y. 1999)) Time Model 15% calculation Calculate remaining term of lease as of petition date and multiply by Example = 100 months left on lease as of petition date means cap is calculated as next 15 months rent Minority view, but consistent with plain language of the statute (see Heller Ehrman opinion Feb. 2011) 31

32 The mechanics of the 502(b)(6) calculation: money model versus time model Recent decision: In re Heller Ehrman LLP, 2011 WL (N.D. Cal. Feb. 11, 2011) Plain language supports the time model. Term of lease refers to length of a lease based on time, not rent. 32

33 502(b)(6) Cap v. Actual Damages 33

34 502(b)(6) Cap v. Actual Damages 502(b)(6) is not a formula for calculating the lessor s claim it is a limit it on damages If the 502(b)(6) cap is greater than the actual damages, the rejection claim is determined by reference to actual damages Example: If there is less than one year left on the lease as of petition date, lessor is not entitled to claim for one year s rent under 502(b)(6). Lessor s s claim for rejection damages is the rent payable under the lease from and after the effective date of rejection. 34

35 502(b)(6) Cap v. Actual Damages: Mitigation Duty to mitigate determined by state law; however, debtors invariably argue that absent evidence of mitigation, lessor s s actual damages are less than the capped claim and seek to reduce rejection damages Requires landlords to: Provide debtor with brief statement of mitigation efforts Provide details regarding new tenant: term, monthly rent, etc. Recalculate actual damages from effective date of rejection by subtracting projected rent under new tenant s lease through end of term with debtor s lease (if not rejected) actual damages may fall below 502(b)(6) cap 35

36 Illustrative Rejection Damage Issues 36

37 Rejection Damage Issues: Rent Concessions/Rent Relief Hypothetical: Lease amendment provides that tenant is entitled to reduced monthly rent conditioned on no events of default. Lessor calculates rejection damages based on original rent Debtor may seek a lower 502(b)(6) cap by arguing that rent reserved under the lease should be determined d by reference to rent concessions under lease amendment Lessor s argument is that 502(b)(6) calculations should revert back to higher rent under original lease terms - Debtor s argument ignores effect of: 502(g) - provides the claim calculations are determined as if the claim had "arisen before the date of the filing of the petition 365(g) rejection is deemed to be a breach that occurred immediately before the filing of the petition 37

38 Rejection Damage Issues: Tenant/Debtor Claims Against Landlord Debtor claims that landlord has payment obligation to tenant (e.g., tenant t allowance) If bankruptcy is filed before payment is due, debtor may seek to reduce 502(b)(6) capped claim by amount of unpaid amount Query whether unpaid obligation reduces actual damages or reduces the capped claim; Landlord argument is that under 502(b) and 502(g), actual damages should take into account rights of setoff with respect to any amounts owed to debtor 38

39 Rejection Damage Issues: Security Deposits Security deposits held by lessors are considered property of the debtor s estate, t typically listed as assets on debtor s schedules Security deposits are applied as a dollar-for-dollar reduction against the 502(b)(6) cap Practice established in the pre-code case of Oldden v. Tonto Realty Corp., 143 F.2d 916 (2d Cir. 1944) Specifically discussed in legislative history Congress did not intend for lessor to be able to offset actual damages against the security deposit and then claim for the balance under 502(b)(6). See In re AB Liquidating Corp., 416 F.3d 961 (9th Cir. 2005) 39

40 Rejection Damage Issues: Letters of Credit Letters of credit historically provide landlords with a greater recovery on rejection damage claims than security deposits because proceeds from the LOC, unlike security deposits, are not considered property of the estate Recently, bankruptcy courts and the Third, Fifth, and Ninth Circuit Courts of Appeals have held that letters of credit are merely a form of security deposit and are treated the same way (dollar-for-dollar deduction from 502(b)(6) cap) See In re PPI Enterprises (U.S.) Inc, 324 F.3d 197 (3d Cir. 2003) 40

41 Rejection Damage Issues: Letters of Credit Well drafted lease providing for LOC will: Avoid security deposit language Provide for a sight draft; require no notice or action by tenant to draw on LOC Recent Fifth Circuit decision held that 502(b)(6) cap does not apply when landlord d draws on LOC and does not file a proof of claim See EOP-Colonnade of Dallas Ltd. P ship v. Faulkner (In re Stonebridge Techs.), 430 F.3d 260 (5th Cir. 2005) 41

42 What if a debtor rejects a lease that it previously assumed? 42

43 Rejection following an assumption: Administrative Claim Bankruptcy Code section 503(b)(7) limits a landlord s administrative claim if a debtor (i) assumes a lease and (ii) later, during the bankruptcy case, rejects the same lease, to: the monetary obligations due under the lease for two years from the later of the rejection of the lease or the surrender of the premises Any remaining damages are deemed a general unsecured claim subject to the 502(b)(6) cap Conditional assumption of leases see In re BI-LO, LLC et al., Case No hb (Bankr. D.S.C.) 43

44 For more information, please contact: Robert L. LeHane PARTNER Bankruptcy and Restructuring Phone: (212) Special thanks to Dana Kane and Vikki Bollettino for their assistance preparing these materials. 44

45 Adequate Assurance of Future Performance By: Jason Binford Kane Russell Coleman & Logan PC March 10,

46 Overview 1. When is "adequate assurance of future performance" required? 2. Case law application and interpretation of the requirement 3. Heightened requirement section 365(b)(3) ) and "shopping "h centers" 46

47 When is Adequate Assurance of Future Performance Required? 47

48 Adequate assurance of future performance relates entirely to the assumption of leases or executory contracts. The full phrase appears in the Code only three times all within section

49 Section 365(b)(1)(B) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee provides adequate assurance of future performance under such contract or lease. 49

50 Section 365(f)(2)(B) The trustee may assign an executory contract or unexpired lease of the debtor only if adequate assurance of future uueperformance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease. 50

51 Section 365(b)(3) Heightened Requirements Assignee must have a similar operating performance and financial condition as the debtor Shopping center restrictions enforceable such as: o Radius o Use o Tenant mix 51

52 Case Law Common refrain: This is a fact intensive inquiry. We must take this on a case by case basis. If that is true, what can be learned from the case law? 52

53 Case Law Intention of AAFP preserving the benefit of the bargain. In re Sapolin Paints, 5 B.R. 412 (Bankr. g p, 5 4 ( E.D.N.Y. 1980) In re Resource Technology Corp., 624 F.3d 376 (7th Cir. 2010) The legal standard is preponderance, so a proposed assignee is required "to show it was more likely than not to perform the obligations under thecontract. t t Is this really the standard? 53

54 In re Resource Technology Corp. Splitting Hairs or a Significant Difference? AAFP Movant Option #1: Must show by a preponderance of the evidence that adequate assurance of future performance has been provided. AAFP Movant Option #2: Must show that assignee is more likely than not to perform under the terms of the lease. 54

55 Other Guidance Provided by Case Law: Movant bears the burden Asimple promise to pay can be sufficient. i It dependsd on who is making the promise. Newly created entities ii cannot point to a payment history, so courts will look at the finances of the new entity's parent company and/or financial backers If the contract is not being assigned, probably don't have to show AAFP at all if there has been no default under the contract. And, just any defaultprobablywon't bbl do. Itmust have been a "material" default. 55

56 Section 365(b)(3) Shopping Centers What is a shopping center? 56

57 In re Joshua Slocum 922 F.2d 1081 (3d Cir. 1980) Factors: A. A combination of leases; B. All leases held by a single landlord; C. All tenants engaged in the commercial retail distribution of goods; D. The presence of a common parking area; E. The purposeful development of the premises as a shopping center; F. The existence of a master lease; G. The existence of fixed hours during which all stores are open; 57

58 Factors H. The existence of joint advertising; I. Contractual interdependence of the tenants as evidenced by restrictive use provisions in their leases; J. The existence of percentage tg rent provisions in the leases; K. The right of the tenants to terminate their leases if the anchor tenant terminates its lease; L. Joint participation by tenants in trash removal and other maintenance; M. The existence of a tenant mix; and N. The contiguity of the stores. 58

59 Section 365(b)(3) 6(b)() versus section 365(f)(1) 6(f)() In re Joshua Slocum 922 F.2d 1081 (3d Cir. 1980) In re Sun TV & Appliances, Inc. 234 BR B.R. 356 (Bankr. D. Del. 1999) In re Track Auto Corp. 367 F.3d 237, (4th Cir. 2004) 59

60 Conclusion Non debtor party should get the benefit of its bargain. No more. No less. Non debtor parties: no guarantees, no windfalls Debtors/assignees: no free rides 60

61 See also: Jason Binford, Beyond Chimerical Possibilities: the Meaning and Application of Adequate Assurance of Future Performance,, 18 Am. Bankr. Inst. L. Rev. 191 (2010). 61

62 Jason Binford Kane Russell Coleman & Logan PC (214)