Daily Development for Friday, September 30, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

LANDLORD/TENANT; ASSIGNMENTS AND SUBLETS; BANKRUPTCY: Landlord cannot terminate assignee's lease because of assignor's bankruptcy where assignment occurred prior to assignor's bankruptcy.

Staples, Inc. v. Moses, 2005 NY Slip Op 51376U; (Sup. Ct. of New York, New York County, July 13, 2005).

The tenant ("Original Tenant") had assigned its interest in the lease in 1992 (with the consent of the landlord) to Staples, Inc. ("Staples"), which operated a Staples Superstore at the premises. Staples always timely paid its rent and complied with all of the other provisions of the lease. But the Original Tenant had filed for bankruptcy on three separate occasions: 1995, 1998, and 2000 (whether the landlord had notice of any of these filings -- as required by the lease -- was disputed).

Staples renewed the lease several times, the last being on February 5, 2005. The landlord claimed that shortly after the last renewal, it first learned of the bankruptcy filings by the Original Tenant, and it thereupon exercised its right to terminate pursuant to the tenant-bankruptcy provision contained in the lease (granting the landlord the right to terminate within a "reasonable time" if the bankruptcy filing wasn't discharged within 90 days).

Staples argued that the termination was improper because: (1) the Original Tenant had filed for bankruptcy after the lease had been assigned to Staples and Staples was at all times financially solvent; (2) Section 365(e) of the Bankruptcy Code (which prevents termination of a lease due solely to the insolvency or financial condition of the debtor-tenant) rendered the anti-bankruptcy provision in the lease unenforceable; and 3) the landlord waived its right under the anti-bankruptcy provision because it knew or had reason to know of the Original Tenant's bankruptcy filings and failed to take any action to terminate the lease within a reasonable time (as required by the lease).

The court, in holding for Staples, relied solely on no. (1) above, finding that Staples had shown a reasonable likelihood of prevailing on the merits and that the equities were in its favor (the case was initiated by Staples as a request for a preliminary injunction pending mandatory arbitration as required under the lease). The court, while acknowledging that the issue was not entirely settled in New York, agreed with the holding in a prior New York case with "remarkably similar circumstances" that "[h]ad the parties intended that the bankruptcy of the named tenant, although out of possession, could terminate the lease, they could have easily have so stated in the lease or modification agreement." The court chose not to follow a contrary New York ruling "given the clear state policy against lease forfeiture and its drastic remedy."

Reporter’s Comment 1:  This was a state court decision and not a bankruptcy court decision, but Staples certainly had a valid argument that, in any event, an ipso facto bankruptcy provision in a lease (granting the landlord the right to automatically terminate a lease if a bankruptcy proceeding is filed by or against the tenant) is void under the Bankruptcy Code and as a matter of public policy. There is no indication in the state court case as to whether the Original Tenant attempted to assume or reject the lease in its bankruptcy proceeding(s), or whether it even considered the lease to be part of the bankruptcy estate. (Pursuant to the assignment agreement executed by the parties, "nothing in this agreement shall relieve [the Original Tenant] from liability for performance under the Lease, and [Original Tenant] agrees to remain bound to the Landlord under the terms of the Lease").

Reporter’s Comment 2:  There are certainly some drafting lessons here. Staples would have been wise to have obtained a specific non-disturbance and attornment agreement from the landlord as part of the lease-assignment agreement executed by the parties. To further protect its interest, Staples also, as part of the lease-assignment agreement, could have obtained the exclusive right to make the election under sec. 365(h) of the Bankruptcy Code to assume or reject the lease in the event of the Original Tenants' bankruptcy (assuming the lease was deemed to be part of the Original Tenant's bankruptcy estate). 

The Reporter for this item is Jack Murray of First American Title Insurance, Chicago office.

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