Boo!!! Lease Default!!!! Major Tenant!!!! Boo!!!
Daily Development for Wednesday October 31, 2001 by: Patrick
A.
By: Patrick A.
Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu
BANKRUPTCY; LEASES; AFFIRMANCE OR REJECTION; GUARANTORS:
Guarantor remains liable for damages on lease following tenant's rejection in
bankruptcy; provision limiting damages in the event of
exercise of a "right to terminate" does not contemplate bankruptcy
rejection; filing of claim in bankruptcy does not limit landlord's claim
against guarantor.
Cromwell Field Assoc. v. The May Department Stores
CompanyCiv. No. JFM-9903249 (D. Md. 3/06/2000); No. 00-1385 (4th Cir. 3/01/01) (unpublished
opinions)
These cases explore some common issues that landlords may
find themselves investigating in uncomfortable detail following this Christmas
shopping season, when retailers may cut their losses for the future by cutting
their leases and diving into bankruptcy.
Although the issues are not earth shaking, they clarify some things, and
obviously the parties thought they were worth litigating to the federal appeals
court.
Caldor was the tenant under a long term shopping center
lease with Cromwell. May was guarantor
of that lease. Caldor filed for
bankruptcy and rejected the lease.
Cromwell sued May on the guarantee, and the present litigation ensued.
May first argued that its guarantee was rendered ineffective
under language of the lease providing for early termination:
"Whenever in this lease provision is made that either
party shall have the right to terminate this lease then, unless in said
provision it is expressly provided otherwise, neither party hereto shall
thereafter have any claim against the other under this lease or on account of
the termination hereof. Notwithstanding
the above, neither party shall be released from liability for defaults
occurring prior to such termination."
The District Court rejected May's claim first because, even
if bankruptcy termination did release the tenant from further obligations, May
would remain liable, in the court's view, as guarantor. The guarantee language specifically stated
that: ". . . [T]he obligations of the Guarantor shall in no wise [sic] be
terminated, affected or impaired
by . . . the relief of Tenant from any of Tenant's
obligation under the Lease, whether by operation of law or otherwise [including
rejection in bankruptcy.]
The court went on to conclude that, in any event, the parties' intent was that the concept of
"right to terminate" did not apply to the rejection of the lease in
bankruptcy, but rather to completion of construction or "lease up"
"kickout rights" set forth specifically in the lease.
Later in another phase of the case, May argued to the Fourth
Circuit Federal Court of Appeals that Cromwell's filing of a claim for damages against
the tenant in the bankruptcy action amounted to a termination of the lease, and
terminated any further liability of the grantor. May noted that a number of cases, largely not involving
commercial leases, conclude that the rejection of a lease in bankruptcy does
not, in and of itself, amount to a termination of the lease, but a filing for
damages
on breach demonstrates an election of the landlord to so
terminate. The court concluded that,
whatever the rule for residential leases, the rule for commercial leases was
clear - rejection ends any right of occupancy of the tenant under the lease and
is effectively a termination of that lease.
Consequently, the landlord's later request in the bankruptcy court for
damages is simply an acknowledgment of what has already occurred, and does not
terminate any rights a landlord may have under a guarantee.
In a subsequent memorandum opinion, the trial court
acknowledged that under the lease itself, the landlord had a duty to mitigate,
and that such duty defined and limited landlord's damages claim against the guarantor,
even following rejection of the lease.
Nevertheless, it is of course quite possible under these circumstances
that any efforts to mitigate will go for naught and the guarantor's liability
will go on for some time, even when the tenant's damages are limited in
bankruptcy.
Comment 1: As indicated, the case is not startling. But the interpretation of the concept "right to terminate" so as to exclude the rejection of the lease in bankruptcy is of some precedential value. Further, the benefit of the specific language in the guarantee preserving the landlord's claim even in the event of such rejection is a good lesson for drafters.
Comment 2: Don't forget the lesson of In re: Farm Fresh Supermarkets of Maryland,
Inc., 2001 Bankr. Lexis 51 (1/12/01) , the DIRT DD for 2/20/01 (on the DIRT
Website), where the court concluded that a landlord was better off in
bankruptcy with a letter of credit guarantee than with a cash security deposit.
Is it possible for landlords now to get such letters in lieu
of or in addition to the cash deposit without running afoul of the preference issue? There are two pretty good arguments favoring
the landlord. First is the argument that the letter of credit is not payment on
a debt, but simply security. Security for a preexisting debt is a
preference. But security for a debt yet to come probably isn't. Second is the argument that the letter is not posted by the debtor, but by the bank. This is harder, but a possible winner especially if the letter of credit is not secured. It's a sure winner if the letter is secured by assets other than those of the debtor tenant.
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