On February 24, 2012, Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware held that the debtor-lessee’s rejection of a lease cannot become effective so long as a non-debtor sublessee maintained possession of the leased premises. The court held that under the Bankruptcy Code and the rejection order governing the case, the Debtors were required to deliver actual possession of the property to the landlord, merely surrendering their own interests in the property was not sufficient. See In re Amicus Wind Down Corp., No. 11-13167, 2012 Bankr. LEXIS 662 (Bankr. D. Del Feb. 24, 2012).
On October 5, 2011, Friendly Ice Cream Corporation and its affiliates filed a voluntary chapter 11 bankruptcy case. As part of their first day pleadings, the Debtors filed a motion seeking the court’s approval of expedited procedures for rejecting certain executory contracts and unexpired leases. The rejection procedures provided that a lease rejection could become effective no earlier than the later of (i) the date of service of a rejection notice on the counterparty, and (ii) the date the “Debtors relinquish . . . control of the applicable premises by delivering keys and/or security codes to the affected landlord.” On October 25, 2011, the court entered an order approving the rejection procedures.
In March 2008, Friendly leased property located in Staten Island, New York from Park Tysen Associates LLC. Several weeks later, Friendly sublet the property to Rappan Restaurants. On December 30, 2011 the Debtors notified Park Tysen and Rappan of their intention to reject the lease and the sublease. The notice proposed December 31, 2011 as the effective date of the rejection. On January 9, 2012, Rappan filed a chapter 7 bankruptcy case and ceased operating its restaurant on the property. However, Rappan failed to remove certain kitchen equipment and restaurant furniture from the premises.
Park Tysen, the Debtors’ landlord, objected to the Debtors’ rejection notice and argued that, because Rappan had not removed the kitchen equipment and furniture, the Debtors had not delivered possession of the property and could not reject the lease. The Debtors argued that by filing and serving the rejection notice they had surrendered the property to Park Tysen, and could therefore reject the lease even though they had not delivered possession of the property. The Debtors relied on In re Chi-Chi’s, Inc., 305 B.R. 396 (Bankr. D. Del. 2004) in which the bankruptcy court refused to allow a debtor to reject a lease retroactively and instead held that the effective date of a rejection is the day the debtors’ “surrendered the premises to the landlords and the landlords were able to enter into agreements with the current tenants.”
The court held that, under the circumstances, merely surrendering the property without delivering possession did not satisfy the requirements of the Bankruptcy Code or the rejection order. The court held that under section 365(h)(1)(A)(ii) of the Bankruptcy Code, when a debtor-sublessor rejects a sublease, the sublessee retains all its rights under the lease including the right to possess the property. Accordingly, even if the Debtors rejected the sublease with Rappan, Rappan would be entitled to remain in possession of the property. Because Rappan had not vacated the property and was entitled to retain possession of the property under the Bankruptcy Code, the only way to remove Rappan and regain possession would be through a state law eviction proceeding.
The court indicated that the pertinent question was which party – the Debtors or Park Tysen – should bear the burden of the cost and delay inherent in evicting Rappan from the property. The court found that, as the Debtors enjoyed the rights and benefits subleasing the property to Rappan, they were also required to bear the burden of evicting Rappan. Moreover, the court noted that under New York law, there is no privity of contract between the original lessor and a sublessee and that Park Tysen could therefore face significant legal challenges if it attempted to evict Rappan. Accordingly, until the Debtors completed eviction proceedings or otherwise convinced Rappan’s chapter 7 trustee to vacate the property, the Debtors could not reject their lease with Park Tysen.
Amicus Wind is consistent with other cases that set the date of surrender as the effective date of rejection of sublet property. Where a sublessee intends to remain in possession, courts have generally allowed the rejection to go into effect as of the date the landlord negotiated a new lease with the sublessee. However, where (i) a debtor-lessee has failed to surrender possession of the premises, even through no fault of its own, and (ii) the sublessee does not intend to negotiate a new lease with the landlord, a debtor-lessee may be stuck with its obligations under the lease indefinitely until it can surrender actual possession to the landlord.
