Daily Development for Thursday, March 16, 2000

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

Note the quite distinct treatment of the nonresidential subtenant and the residential tenant in the two cases.

BANKRUPTCY; LEASES; SUBTENANT BANKRUPTCY; CONSTRUCTIVE POSSESSION: A subtenant, who has leased the property out to retailers does not have a sufficient possessory interest in the premises to interpose the stay in its Chapter 11 case to stop the lessor from enforcing a prepetition termination of the primary lease.

In re Policy Realty Corp., 1999 U.S. Dist. LEXIS 10633 (S.D.N.Y. 1999).

Policy was the tenant under a sublease from CoOp. The rent under Co Op's master lease was to be determined through an appraisal method, and in one year, after a dispute about the rent setting, an arbitrator appointed pursuant to the lease increased the rent by 610%, to $700,000 per year. The old rent had been $110,000. CoOp defaulted on the master lease and the landlord invoked an accelerated termination clause.

On the day that the termination was to be effective. Policy brought a state court action to enjoin the termination of the lease. The trial court granted a temporary restraining order barring the termination, but an appeals court ordered that the tro be dissolved unless Policy posted a bond.

The court ordered the bond posted by 5 o'clock p.m. on September 9th, 1998. Policy instead filed a bankruptcy case at 4 o'clock on September 9th, and argued that the action to terminate the master lease was stayed because it would have an impact on an asset of the bankruptcy debtor the sublease attached to that master lease. The master landlord sought a ruling from the bankruptcy court that the stay did not affect the termination of the master lease, but the court refused to so hold and in fact ruled that the landlord had violated the stay by sending Policy and other subtenants eviction notices.

On appeal to the Second Circuit: Held: Reversed. The lease was effectively terminated prepetition because the automatic stay would not toll the running of the time period set by the state court. The mere passage of time is not an action or proceedings within the intendment Section 362(a), stayed automatically upon the filing of a case.

The bankruptcy statute states that the automatic stay has no impact on an action by a lessor to obtain possession of the premises that is the subject of a nonresidential lease that has been "terminated by the expiration of the stated term of the lease" prior to filing. The court ruled that "terminated" is a question of state law, and that termination can occur through conditional limitation. The lease, in other words, is terminated if no action is taken to cure the default by a certain time. The fact that the time has not yet run does not mean that the lease termination is not effective when the time has run, notwithstanding the intervention of a bankruptcy. This is true even if the period within which the condition may be invoked runs beyond the time of filing bankruptcy, as here.

The court noted that opinions in which the subtenant's stay has prohibited the termination of the primary lease, such as In re 48th Street Steakhouse inc., 835 F.2d 247 (2d Cir. 1987), involved efforts to terminate the lease postpetition.

Further, while a party having "a mere possessory interest in real property, " such as a holding over tenant, has an interest sufficient to trigger the automatic stay, for purposes of the automatic stay the debtor as subtenant had no possessory interest here. To hold otherwise would give rise to the possibility that "every nonresidential lease termination could ultimately be frustrated by the last minute filing of a Chapter 11 proceeding."

Editor's Comment 1: The construction placed upon the bankruptcy statute could easily go the other way if he statute is read literally. It states that the stay is not effective if the term of the lease has terminated prior to the filing of a bankruptcy petition. The court itself admits that the lease did not terminate until one hour after the filing of the petition, but the court concludes that the stay has no effect because no further action of termination was necessary for the lease to end.

The court is correct that to read the statute otherwise would render many landlords subject to being frustrated by last minute bankruptcy filings. But isn't that the nature of the bankruptcy process to frustrate actions by creditors that would destroy the value of the bankrupt's estate? Frustration is part of the process. Why is it such a bad thing here?

The editor is not particularly fond of the intervention of bankruptcy to prevent the termination of a lease under the circumstances of this case, but notes simply that the ruling of the court here does not literally follow the language of the statute. An opposite ruling would have the effect of preserving a potentially valuable asset in the hands of the bankrupt subtenant.

Editor's Comment 2: Note the similarity of the issue here to the question of whether an automatic stay will intervene to prevent the running of a statutory redemption period.

BANKRUPTCY; AUTOMATIC STAY; HOLDINGOVER TENANT; PROPERTY INTEREST: Even after the warrant for eviction issued, the tenant of a rentcontrolled apartment in New York had a sufficient interest in the property, by force of his actual possession, to invoke the automatic stay against the landlord's efforts to recover possession after the holdingover tenant commenced a Chapter 13 bankruptcy.

In re Muniz, 1999 U.S.Dist. LEXIS 4060 (S.D.N.Y.1999).

But it was error for the Bankruptcy Court not to consider the seemingly ample grounds for lifting the stay, for cause under Section 362(d), including the tenant's long history of rental defaults and employment of tactics to frustrate and delay the landlord. The Bankruptcy Court's record did not "show any consideration of the landlord's interest in the premises..." 4060 at *12. Hence, remand was required.

Reporter's Comment: Remand?

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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