Daily Development for
Thursday, June 29, 1995

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

BANKRUPTCY; PREFERENCES; LEASE TERMINATION PAYMENT: Pre-petition payment to terminate lease is recoverable as a preferential payment. In re Upstairs Gallery, Inc., 167 B.R. 915 (9th Cir. BAP 1994). Debtor sought to recover a lease termination payment it made to its landlord within 90 days of filing its bankruptcy case. Landlord resisted. The Bankruptcy Court had held that an obligation of rent arises on the date it is due and therefore, found that no antecedent debt existed and, therefore, there was no preference, citing inter alia In re Coco, 67 B.R. 365, 370 (Bankr.S.D.N.Y.1986)

The Bankruptcy Appellate Panel disagreed and reversed, holding that an obligation to pay rent arose when the lease was entered into, and, therefore, the termination payment was on behalf of an antecedent debt and could be recovered as a preference. The court further rejected the lessor's argument that the settlement created a "new obligation for which the payment may be deemed outside the scope of 547(b)(2) as `contemporaneous exchange for new value.'" Id. at 919.

There was no indication in the case that the payment was in fact related to prior defaults. The court focussed on the argument that the original lease agreement created an obligation to pay rent. As the lease termination excused the landlord from providing possession and services in the future, the court theorized, the only basis for the tenant's payment to the landlord was to escape the contract obligation that the tenant incurred as of the signing of the lease - an antecedent debt.

Note: The court says nothing about whether the lease itself is still intact, or whether the landlord has any claim for breach of the lease or other remedies. Presumably the landlord is not interested in giving the bankrupt the opportunity to affirm the lease at this point, as there is a new tenant.

Comment: The editor characteristically is suspicious of bankruptcy preference rulings, believing that bankruptcy courts tend to "tilt" toward the building up of the estate and against individual creditors' claims. After several false starts at writing a note critical of this case, however, the editor finally has surrendered and concedes that there is some logic to the court's position. DIRT readers are encouraged to help the editor on this one. "Kickouts" are a common business practice in commercial leasing, and the decision endangers the confidence with which parties can bargain for them. Any good arguments against the result.

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