Daily Development for Tuesday, February 7, 2006
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

BANKRUPTCY; LEASES; ASSUMPTION OR REJECTION; TIMING OF REJECTION:  Bankruptcy court may make its approval of rejection of an unexpired nonresidential lease retroactive to the date the debtor-lessee moved for approval of rejection, in light of the debtor's lack of delay, the amount of rent involved, and the lessor's "improper motives."

Pacific. Shores Development LLC  v. At Home Corp. (In re At Home Corp.), 392 F.3d 1064 (9th Cir. 2004), cert. denied, 2005 U.S. LEXIS 5547 (U.S., Oct. 3, 2005)

The lessor here objected not to the rejection of its leases, but to retroactive application of the order approving the rejection to the date the motion was filed. A later effective date (i.e., the date of entry of a court order approving the rejection) would mean that the debtor would have owed the lessor an additional $ 1 million in administrative rent. The Ninth Circuit ruled that the bankruptcy court had equitable authority under § 105(a) and § 365(d)(3) of the Bankruptcy Code to approve retroactively the rejection of the debtor's unexpired nonresidential leases.

The Ninth Circuit also ruled that the bankruptcy court did not abuse its discretion by granting retroactive approval, even where the effective date was prior to the lessor's resumption of possession of the leased premises. The Ninth Circuit reasoned that the equities favored the debtor because it promptly moved for authorization to reject the leases and there was no appreciable delay between the filing of, and the actual hearing on, the motion to reject; furthermore, the bankruptcy court could consider, when deciding whether to make its approval retroactive, the amount of rent owed under the lease, that the lessor appeared only to be attempting to obtain administrative rent and not to enforce its right to re-let the premises quickly, and the fact that the debtor had never occupied the leased premises (which would make it easier for the lessor to re-let the property).

The court referred to the recent so-called Shopping Center Amendments contained in the Bankruptcy Amendments and Federal Judgeship Act of 1984, which were intended to protect the interests of commercial landlords who, compared to other creditors, were deemed to be unfairly disadvantaged because they were forced to continue extending credit, in the form of rent, during the pendency of bankruptcy reorganization proceedings. These Amendments were designed to ensure that a commercial tenant that seeks protection under Chapter 11 continues to perform its obligations under the lease--including the obligation to pay the full amount of rent -- until the lease is rejected. By requiring the tenant to pay administrative rent until it rejects the lease, and by providing for automatic rejection of the lease after 60 days, the Amendments ensure that the tenant determines promptly whether to assume or reject the lease, rather than taking advantage of the automatic stay. The effective date of rejection of a lease determines when a debtor's obligation to pay rent ceases.

The Ninth Circuit acknowledged that under the "majority view," the rejection of a lease becomes effective upon entry of a court order approving a trustee's or debtor's motion to reject an unexpired nonresidential lease, and that this view regards court approval as a "condition precedent" to the rejection of a lease. In most cases a lease will be considered rejected as of the date of entry of the order approving the rejection, and the Ninth Circuit noted that "only in exceptional circumstances will the court adopt a retroactive date."

Nonetheless, the Ninth Circuit ruled that under the equitable powers granted to a bankruptcy court under § 105(a) and § 365(d)(3) of the Bankruptcy Code, "in appropriate cases, retroactive lease rejection may be 'necessary or appropriate to carry out' this provision of Title 11." Id. at 1070; although "[t]hose powers are limited and do not amount to a 'roving commission to do equity.'"  Id. The Ninth Circuit reasoned that nothing in § 365(d)(3) or the applicable case precedents, "or in logic," prohibited a bankruptcy court from considering the practical effect of a tenant's lack of possession when balancing the equities. The court further reasoned that neither consideration of the landlord's conduct and motives, nor the amount of rent at stake, were necessarily irrelevant to the bankruptcy court's equitable deliberations.

Reporter’s Comment: This case should make shopping center landlords shake in their boots (at least in the Ninth Circuit). The Ninth Circuit ignored the overwhelming "majority view" that rejection should not be effective until the court enters an order so providing. The view adopted here eviscerates the "Shopping Center Amendments" that provide special protections to shopping center landlords under § 365(d)(3), and which were adopted for the very purpose of avoiding results such as that in the Pacific Shores case. As the Ninth Circuit noted, "Previously, a debtor could file a Chapter 11 bankruptcy petition and then maintain control of the leased property for the entire duration of the bankruptcy proceedings, even if the debtor had ceased operations and had vacated the premises. The automatic stay prevented the landlord from evicting the debtor or regaining possession of the leased space. The landlord lost money, and the extended vacancy hurt other tenants in the same shopping center a s the bankrupt tenant because of decreased customer traffic." Id. at 1068.

The Ninth Circuit also noted that under § 503(b)(1)(A), the landlord eventually received only the "actual, necessary costs and expenses of preserving the estate," rather than the rent that would have been due under the terms of the lease. Therefore, "landlords could not rent the unused space until the proceedings terminated, and they received only 'an amount equal to the reasonable value of the debtor's actual use and occupation of the property' during those proceedings." As the Ninth Circuit correctly noted, "The Shopping Center Amendments solved those two problems by ensuring that a commercial tenant who seeks protection under Chapter 11 continues to perform  its obligations under the lease--including the obligation to pay the full amount of rent ‘notwithstanding section 503(b)(1)’ -- until the lease is rejected. By requiring the tenant to pay administrative rent until it rejects the lease, and by providing for automatic rejection of the lease after 60 days, the Amendments apparently ensured that the tenant [would] determines promptly whether to assume or reject the lease, rather than taking advantage of the automatic stay.”

Reporter’s Comment  2: There was a substantial sum of money at stake -- $1 million -- that the landlord now could not collect based on the Ninth Circuit's ruling. The Ninth Circuit attributes a nefarious, selfish motive to the landlord's actions in this case, i.e., that (according to the bankruptcy court) it was solely concerned with "running the administrative rent . . . [rather than by] a concern to get this indisputable right to start re-letting the premises as quickly as possible." The Ninth Circuit approves this finding of the bankruptcy court without discussion, stating merely that "A landlord's conduct and motives are relevant to a bankruptcy court's equitable deliberations." Id. But the landlord was justifiably concerned and certainly within its rights, both statutory and equitable, to contest the possible loss of $1 million in rent otherwise due under the lease, regardless of whether the premises were vacant or occupied. It is not surprising that the landlord appea led this case all the way to the U.S. Supreme Court (which recently denied certiorari, on October 3, 2005).

Reporter’s Comment 3:  Perhaps the most frustrating aspect of this case is the failure of the Ninth Circuit to set forth any "bright line" guidelines that might be of benefit to shopping center landlords to address this problem in the future. According to the Ninth Circuit:

So much for the effectiveness of the "Shopping Center Amendments."  

Editor’s Comment 1: The editor certainly endorses the comment that the Bankruptcy Act should not be regarded as a roving commission to do equity for Bankruptcy judges.  Would that the Bankruptcy judges agreed.  It’s expensive to take every inappropriate ruling up on appeal.  Every time a court of appeals opens up a new discretionary opportunity, bankruptcy judges are empowered to eviscerate legitimate contract expectations (even expectations based upon the Bankruptcy Act) in order to bring about what the individual judge views as an “appropriate” outcome in an individual case. 

As bankruptcy is the tactic de jour for many failing businesses, this makes it difficult for the marketplace to limit concerns about the impact of bankruptcy upon business expectations, thus leading to lots more hard and expensive bargaining and anti-bankruptcy barriers and safeguards.  This all costs money.  Is helping the bankrupt debtor really worth overburdening those still in the marketplace with fear-driven bargaining tactics?

Editor’s Comment 2: That being said about the general state of the bankruptcy law, the editor is more patient with the court’s particular ruling on the stated facts.  The tenant never took possession.  The landlord knew that the debtor was not going to assume, and, according to the court, the landlord just sat on the property instead of initiating efforts to relet.  If this characterization of the situation is correct, perhaps there are some equitable considerations here, in light of the strong tilt favoring mitigation duties throughout the Act.

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