Bankruptcy Court Holds Debtor-Assignor Is Not Off the Hook for Pre- and Post-Assignment Damages Under Lease Assigned Pre-Bankruptcy Because Landlord Never Granted a Release

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If you really want to be released from your lease obligations and those of your assignee, you need to get a landlord release at the time of assignment.

TAKEAWAYS

  • An assignor tenant’s lease obligations survive an otherwise permitted prepetition assignment to an affiliate, absent a release from landlord.
  • Even a material post-assignment amendment to which it was not a party will not release the debtor-assignor of liability for damages under the entire lease, as amended, particularly where the assignee was an affiliated special purpose entity without assets created for the sole purpose of holding the lease.
  • Landlords should not be quick to conclude that assigning tenant does not remain obligated on the assigned lease, whereas it is prudent for assigning tenants who wish to be released to obtain a formal landlord release.

Arecent bankruptcy court ruling highlights why landlords, particularly in light of the ongoing COVID-19 pandemic, should continue to enforce their rights under commercial leases notwithstanding a tenant or former tenant’s bankruptcy filing; and conversely, why assigning tenants should obtain a landlord release if that is what they expect to happen as a result of a prepetition assignment. As demonstrated by In re RGN-Group Holdings, LLC, No. 20-11961 (BLS), 2021 WL 4203336 (Bankr. D. Del. Sept. 15, 2021), even where a lease was assigned prepetition by the debtor to a non-debtor entity, a landlord may be allowed a claim for damages against the debtor, including for unpaid rent, commissions and other ancillary costs, capped by section 502(b)(6) of the Bankruptcy Code.

Background
Prior to filing for chapter 11 as a part of the RGN-Group cases, H-Work LLC (H-Work) was a tenant under a commercial seventh amended lease with landlord Teachers Insurance and Annuity Association (TIAA). The lease permitted assignment to entities under H-Work’s common ownership or control, and prior to filing bankruptcy, H-Work assigned the lease to RGN-Dallas, an assetless, commonly controlled special purpose entity that did not seek bankruptcy relief. Under the assignment, RGN-Dallas assumed the lease obligations and liabilities, but H-Work never obtained a release from TIAA.

After the assignment, RGN-Dallas and TIAA entered into two lease amendments—the Eighth and the Ninth Amendments. The Eighth Amendment extended the lease term by a year to allow the parties to negotiate the Ninth Amendment. The Ninth Amendment provided for a larger office space in a different building, higher rent and a 13-year lease term. It also required TIAA to move tenants out of the space so that RGN-Dallas could move in. H-Work did not execute the Eighth and Ninth Amendments.

Despite TIAA subsequently making the space available, RGN-Dallas never moved. After expiration of the Eighth Amendment, and the failure by RGN-Dallas to timely pay rent, TIAA terminated the hold-over tenancy of RGN-Dallas. In the meantime, H-Work filed for chapter 11 relief.

TIAA filed a proof of claim against H-Work in the amount of $5.7 million, reflecting its calculation of the cap on landlord damage claims under section 502(b)(6) of the Bankruptcy Code. Except for unpaid rent arising under the Eighth Amendment, all other damages asserted arose under the Ninth Amendment, to which the Debtor H-Work was not a party. If allowed, TIAA’s claim would be paid in full under H-Work’s confirmed chapter 11 plan of reorganization.

Contractual Privity Remained Between Debtor H-Work and TIAA
H-Work objected to the claim. It argued, among other things, upon execution of the Eighth Amendment by only RGN-Dallas and TIAA, it lost privity with TIAA and could not be liable for the Eighth or Ninth Amendments to which it was not a party. In response, TIAA argued that H-Work’s lease obligations survived the assignment under Texas law because H-Work was never released by TIAA.

The bankruptcy court agreed with TIAA. According to the court, under Texas law, an assignment does not relieve a tenant-assignor’s continuing lease obligations, and privity is not broken, unless affirmatively released by the landlord.

Material Change Doctrine
H-Work also argued that the bankruptcy court should apply the material change doctrine to infer or impose a release of post-assignment obligations. The doctrine “is intended to prevent an injustice being worked upon an assignor when an assignee signs on to new and different terms to which the assignor had never agreed.” According to H-Work, the Ninth Amendment materially changed the terms of the lease by providing for a new building, higher rent, larger office space, and a 13-year lease term—terms that H-Work argued it did not bargain for, but instead were bargained for by RGN-Dallas and TIAA.

The court rejected the argument. Texas, unlike certain other states, does not recognize the material change doctrine. And even if it did, the court noted that it made no sense to apply it where the debtor-assignor’s lease obligations were assigned to an “assetless special purpose entity created to hold the [l]ease,” where the “same individual was and continues to the authorized person for both RGN-Dallas [assignee] and [Debtor-assignor].” The court further observed that, “[f]rom TIAA’s view, the assignment was presumably without material economic or legal consequence, since it was continuing to deal with the same corporate entity that had been its tenant all along.”

Consequently, the court held that H-Work would be liable if RGN-Dallas breached the Ninth Amendment.

RGN-Dallas Breached the Ninth Amendment
Finally, H-Work argued that RGN-Dallas never breached the Ninth Amendment because RGN-Dallas did not occupy the new space and the relocation never occurred.

The bankruptcy court disagreed, finding that the Ninth Amendment was enforceable and binding upon the execution date, such that TIAA could recover damages for breach notwithstanding RGN-Dallas’ failure to take possession of the space. Because TIAA was required to front-load costs to prepare the new space and relocate tenants in the other building and RGN-Dallas had failed to pay rent, the court held the Ninth Amendment was breached and, subject to certain adjustments, it allowed TIAA’s proof of claim in the reduced amount of approximately $3.4 million.

Planning and Exploring Options
This decision demonstrates that landlords should not quickly conclude that a former assigning tenant is relieved of liability for post-assignment lease defaults, even if the assignment was permitted under the lease. It might have been easy and understandable for the landlord to have walked away from the prior tenant, especially since the assigning tenant filed for bankruptcy. In this case, however, the assigning tenant’s chapter 11 plan provided for full payment of unsecured claims of this type, and as such it appears the landlord’s thoroughness and persistence will pay off.

Conversely, this case teaches an important lesson to assigning tenants. Those who believe that a release of future lease obligations post-assignment is the benefit of the bargain would be wise to obtain a formal landlord release. Otherwise, they risk future liabilities under both the as-assigned and as-potentially amended lease.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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