Daily Development for Monday, February 9, 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; ASSUMPTION OR REJECTION; ABANDONED PROPERTY: Where lease is rejected, court has limited discretion to condition approval of abandonment of debtor tenant's property on tenant's removal. Absent danger to public health and safety, it's the landlord's problem, and maybe no administrative rent is payable for the time the stuff remains. In re Malden Mills, 2004 WL 89470 (1st Cir. BAP Mass 2/21/04) This case almost completely reverses a very generous ruling (apparently) in the landlord's favor following the tenant's abandonment of a premises in which it left a number of chemical storage tanks and considerable other junk and detritus from its lengthy manufacturing activities there. It was apparently the landlord's contention that it had permitted the tenant a lot of latitude on the premises because the parties expected that the tenant would purchase it, and in fact, the landlord argued, the last lease they entered into was in effect a financing device. But the argument came too late, and the court treated the agreement as a standard lease. The court first determined that the landlord could not collect for damage to the property occurring during the period preceding the most recent lease, which it had rejected in bankruptcy. The earlier lease had made landlord responsible for maintenance, (while the newer lease, the rejected one) made tenant responsible to yield up the property in its condition as of the commencement date of the newer lease. The landlord had argued that it had been prevented from having access to the premises during the time of the earlier lease, and had assumed that tenant was purchasing the building, so that the tenant should not be able to lay the poor condition of the premises during the prior term at the landlord's feet. This amounted simply to an argument that the landlord hadn't paid adequate attention to the documents it signed, and the appeals court rejected a multimillion dollar finding for the landlord on this count. The court spent quite a lot of time analyzing what the measure of damages might be for damage to the property, evaluating the cost of repair versus the diminution in value of the premises. It noted that in most cases the degree to which the damage has diminished the value of the property will provide a "cap" to any claim for repair costs. In the end, this test was applied only to damages arising after the commencement of the most recent lease, in 1999. As there was no clear evidence of the value of the property as of 1999, the court remanded for further proceedings on this issue. The more important discussion in the case, however, dealt with the questions of whether the court could condition the tenant's abandonment of personal property on the tenant's removal of that property from the premises (or paying for that removal) and whether the tenant could be held liable for administrative rent resulting from the fact that the personal property had remained on the premises for some time after the tenant had vacated and the trustee had abandoned. As noted above, the property consisted of some chemical storage tanks installed by the tenant and assorted junk. The court noted that Section 544 of the Bankruptcy Code provides that "[a]fter notice and a hearing, [a debtor in possession] may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate." Authorities have held that upon abandonment the property reverts to the party with the possessory interest. The Debtor claimed that it had filed a notice of its intend to abandon on January 29, 2002, in a responsive pleading, and had in fact filed a motion to abandon on April 22. The motion proposed that the abandonment be effective as of January 28, 2002, the date the rejection of the lease became effective. The court concluded that the Bankruptcy Code language dealing with abandonment of personally property is significantly different with that addressing abandonment of leases. In the latter case, the court must actually approve the abandonment of the lease. But abandonment of personal property generally speaking, is the right of the Debtor, subject only to a very restrictive review. The court noted that a court cannot authorize an abandonment without protecting the public health and safety, but that this is a narrow exception to the general abandonment power vested in the trustee. As a consequence of this analysis, the court decided that (a) the lower court was without authority to condition the abandonment of the personal property upon its removal from the premises, as there was no evidence of any public health or safety concern; and (b) the date of the abandonment probably was the date of the filing of intent to abandon, rather than the date of court approval, which was, apparently coincidentally, exactly one year after the original notice of intent. The court did note that in extraordinary circumstances a bankruptcy judge could move the effective time of abandonment of personal property either earlier or later than notification of intent, but indicated that there were no factors yet adduced in this case that would justify such a decision. It remanded for a determination of the actual date, but left little doubt as to the result it expected. The court then turned to the question of whether anything was payable the period of time after the lease had been rejected and the premises vacated that there was a significant amount of personal property still on the premises. Remember that in the context of this case, this was a period when the parties were wrangling as to who should bear the cost of removing the junk. In fact, the trial court ruled - after a year - that the tenant should bear the cost. As described above, the BAP reversed that determination. But what about all that time that the stuff just sat there? The court held that so long as the property was that of the tenant, the landlord may have had a claim for storage costs, that would be an unsecured claim in the tenant's bankruptcy. Even that claim, however, was subject to the landlord's duty to mitigate damages. It suggested that the landlord could have reduced the rent claim by removing the property to separate storage (holding the tenant liable for the costs - again an unsecured claim) - or even by selling the property. Although the court doesn't say so, there might be a problem that if the landlord sold the property while it was still part of the tenant's estate, the proceeds in fact would be payable to the estate, not to the landlord. That might depend upon the availability and type of distraint relief available to Massachusetts landlords. Finally, once the property had been abandoned, the court was of the view that the landlord had no claim for rent or storage costs against the tenant. The tenant no longer owned the stuff!! There was possibly a brief period between vacation and formal abandonment (depending upon what the bankruptcy court on remand determined the abandonment date to be.) It isn't exactly clear whether there is an additional damage claim to move the stuff as of the abandonment - if not moved before - but the editor is guessing, perhaps in vain, that the court would allow that as a damage claim if the landlord's conduct was reasonable. The above discusses the possibility of claims as unsecured creditors in the bankruptcy - not exactly a rich payoff. But the court then turned to the real issue - whether administrative rent would be payable for the period of time that the tenant's property remained on the premises. Here the court noted that precedent has established that even after a lease has been rejected, the debtor tenant's failure to vacate immediately the property might give rise to a claim for administrative rent under Section 503(b)(1)(A). But under Section 502(g), the claim is limited to the value to the estate of the continued occupation of the property in question. Tossing the landlord a bone (which eventually the landlord wouldn't be able to chew), the court stated that the amount of the post-rejection administrative expense claim is not limited to costs "without which rehabilitation would be impossible," but includes all costs "ordinarily incident to operation of a business." This would include commission of a tort by the business. The court commented that the administrative priority here is based upon "fundamental fairness." (Whatever that is in the bankruptcy context.) But, in the court's view, debtor did nothing here post rejection that imposed damages on the landlord. "Prepetition, the Debtor entered into several leases with [landlord] for use of the Building. The Debtor apparently vacated the premises around the time it filed a bankruptcy petition and it timely requested that [the Lease] be rejected. Any claim for use and occupancy . . . results from the debtor's prepetition conduct." Thus: "the genesis of [Landlord's} claim was the prepetition lease of the Building, not some dealings resulting from the postpetition operation of [Debtor's] business. For that reason, it would appear that neither fundamental fairness nor economic necessity warrants any claim on a priority basis." Note that this is a very subtle distinction. If the Debtor in fact had operated its business postpetition, then, even though it was no longer operating the business when its stuff occupied the landlord's premises, the trespass tort might have emanated from postpetition activity and thus might have been construed as arising from conduct deemed beneficial to the estate. But because the Debtor stopped business immediately upon filing the petition, the leaving of the property on the premises stemmed entirely from prepetition activity, and thus gave no value to the estate, which existed only postpetition. So the landlord will wait in line with its hat out to see what falls from the unsecured table. Even then, the hat will be several sizes smaller because it had a duty to mitigate damages and had no claim for storage after the tenant abandoned the personal property. Comment 1: All in all, very, very bad news for landlords caught with significant holdover junk on the premises. There is only the smallest of windows for discretion on the part of the bankruptcy court to provide protection for the landlord, and, unfortunately, the court gives us no hint - other than the problem of hazardous materials - as to what might support such discretion. Comment 2: The court comments that this decision is consistent with the bankruptcy attitude that all creditors must be treated the same. But the landlord is the only creditor whose property continues to be adversely affected by the presence of the debtor following the rejection of the business relationship between them. The notion that the ownership and responsibility of the personal property transfers to the landlord as a consequence of its right to possession of the premises is absurd. Unless the parties have agreed in advance, there is no reason to believe that they have reached any such understanding, nor that the law should impose possession upon an unwilling landlord. Bankruptcy legislation recognizes the special nature of leasehold agreements in the panoply of contractual rights involved in bankruptcies, but, as this case indicates, bankruptcy courts consistently are unwilling to honor the distinction and continually mash everything into a single mold. Readers are encouraged to respond to or criticize this posting. Items reported on DIRT and in the ABA publications related to it are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. 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