Daily Development for Thursday, April 15, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

BANKRUPTCY; LEASES; DAMAGES: Damages for failure to maintain property or restore it to original condition at lease end are determined as of the end of the lease, and hence, even though the lease is not terminated until the tenant rejects it in bankruptcy, the termination “relates back” to date of filing and the damages are treated as prepetition damages and not as higher priority administrative expenses.

Treesource Industries, Inc. V. Midway Engineered Wood Products, Inc., (In Re Treesource Industries, Inc) 2004 U.S. App. Lexis 7033 (4/3/04)

The lease in this case stated as follows:
“. . . Lessee will . . . keep and maintain the said premises and will return the same to the Lessor in the same condition as the same was in at the commencement of this lease, reasonable wear and tear excepted. . . “

Later, the parties amended the lease to permit the tenant to demolish existing structures and build others. There was a removal provision added, which provided:
“ Upon termination of the lease, Lessee shall remove all fixtures and equipment on the premises and shall, with respect to th improvements made after March 1, 1997, reomve such improvements, footings, floors, foundations and shall regrade the premises to natural contours after removing all debris . . . “

In February, 1999, in connection with a proposed asset sale, apparently Landlord signed a paper that said that Tenant had reached “minimal compliance” with its maintenance obligation.

In September, 1999, tenant’s parent gook it into bankruptcy. The period for assumption or rejection of the lease was continuously extended for over two years, until Halloween, 2001. A few weeks prior to this final deadline, tenant rejected the lease and shortly thereafter a confirmation plan was approved.
A few months after that, landlord filed an administrative expense claim dealing with tenant’s failure to remove the concrete building slab it had installed and to restore the premises. In addition, it sought an additional recover for the tenant’s failure to repair and maintain the balance of the premises.

Held: All of the claims, including the repair claim, related to breaches by the tenant occurring as of the termination of the lease, which, for bankruptcy purposes, “related back” to the moment of filing, and thus all claims constituted unsecured claims for contract damages.

The court acknowledged that, during the period of time that a tenant remains in occupancy prior to electing to affirm or reject, it is liable for performance of the lease. The court indicated that it had already held in prior cases that all post-filing, pre-rejection damages had administrative expense priority. Here, however, the court concluded that the landlord’s claims did not fit that description, as, upon rejection, they became effectively pre-petition claims. The court noted that the removal obligations here were distinct from obligations to pay taxes or rent, which arise during the possessory term, pre-rejection.

But what about those maintenance responsibilities? The landlord argued that these responsibilities were ongoing and that it was entitled to treat a portion of the deferred maintenance as occurring during the post-petition, pre-rejection period. The court demurred:
“The terms of the lease provide that the premises must be returned in the same condition as at the commencement of the lease. Therefore, if the maintenance were sub-par and [landlord] had any claim, it would only have arisen when the premises were returned. Although the lease provided that [tenant] had to keep and maintain the premises, the only relevant time tha tthe premises had to be in propery condition was when [tenant] returned the land - when the lease ended. When [tenant] rejected the lease, it simultaneously breached this obligation.”

Comment 1: What does this say for future lease drafters? Is it necessary to create some kind of ongoing responsibility to maintain, perhaps in response to regular inspections by landlord? Although this might have done some good here, such a provision is likely to be difficult for both sides to carry out, with the likely consequence that it would be deemed waived by the time of any bankruptcy. Nevertheless, in a case in which these considerations are critical, it may be an approach to be considered.

Comment 2: What if the language had said simply “maintain and repair the premises,” and had no language concerning the condition at the time of the return of the premises? Would this have mattered? As a practical matter, probably not, since at least some courts have viewed maintenance and repair provisions as violated, if at all, when the tenant fails to return the premises in good order, and not before.

Comment 3: There has been some argument, relating to other bankruptcy issues, that a lease is not deemed “terminated” upon post-petition rejection, but only “breached.” This case says that the lease terminated. Did it really mean that?

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