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


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 No. JFM-9903249 (D. Md. 3/06/2000); No. 00-1385 (4th Cir. 3/01/01) (unpublished opinions)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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