Lease Termination: Do You Really Mean It?

by Pepper Hamilton LLP

In re 2408 W. Kennedy, LLC, 512 B.R. 708 (Bankr. M.D. Fla. 2014)

A commercial landlord sought relief from the automatic stay so that it could complete prepetition eviction proceedings against the debtor. The debtor objected, arguing that it had a right to assume the lease. The case turned on whether the landlord effectively terminated the lease prepetition.

The debtor operated a nightclub at a location that it leased from the landlord. The landlord sent the debtor a default notice for failure to make lease payments and on the basis that the debtor defaulted on a promissory note that constituted a default under the lease through a cross-default provision.

Based on the cross-default, the landlord contended that the lease was “no longer in effect” and the debtor was “occupying the premises as a Tenant at Will.” (There is an inference that the landlord relied on the cross-default because under state law the tenant would have had a right to cure the lease payment default and reinstate the lease.)

The landlord also insisted that the debtor continue paying rent under a supposed month-to-month tenancy. When the debtor failed to pay rent, the landlord gave a short pay-or-quit notice, and when the debtor again failed to pay, the landlord sued to recover possession of the premises.

A state court entered an order obligating the debtor to pay both past due rent and ongoing rent into the court registry. After the debtor was late on a payment by less than a day (due by 5:00 p.m. one day, but not deposited with the court until 8:00 a.m. the next morning), the court entered a default judgment for possession and issued a writ of possession. After considering the debtor’s request for reconsideration, the court ordered the debtor to vacate the premises. One day before the deadline for vacating, the debtor filed bankruptcy.

The landlord requested relief from the automatic stay, arguing that the bankruptcy case was a bad-faith filing since the debtor needed the premises to operate its nightclub, but could not assume the lease because it was terminated prepetition. While acknowledging that it could not assume a terminated lease, the debtor disputed that the lease was terminated. The landlord argued that the lease was terminated either (1) when it notified the debtor of the cross-default, or (2) when the state court entered a judgment for possession and issued a writ of possession.

Addressing the procedural argument, the bankruptcy court determined that under state law the lease was not terminated by entry of a final judgment for possession or issuance of a writ of possession.The court reasoned that there are typically three remedies for default under applicable state law: (1) terminate the lease and take possession, (2) take possession for the account of the tenant and hold the tenant accountable for the difference between rent that was due and what the landlord actually received, and (3) sue the tenant for rent as it becomes due. The court saw this as clear confirmation that simply retaking possession does not terminate a lease (since it was also consistent with acting for the tenant’s account).

There was an additional argument that a debtor cannot assume a lease if the debtor has lost possession regardless of whether the lease is terminated. However, a tenant does not lose possession under state law until the writ is executed, and until then a tenant can prevent removal by tendering any rent in arrears with interest. So the lease is not terminated and the debtor can still assume the lease even if a judgment for possession has been entered and/or a writ of possession has been issued.

As for the supposed termination based on the promissory note cross-default, the court did not agree that the landlord established that there had been a default. The debtor apparently made all of the monthly payments due under the note. The supposed default was based on a failure to pay late charges of $169.26 – since payments were due on the 5th of each month and the debtor paid on the 7th one month. However, late charges were not automatic under the note, and the noteholder did not assess late charges until after the bankruptcy was filed. Consequently, the landlord did not have a basis for terminating the lease prior to bankruptcy.

Furthermore, even if the debtor had defaulted under the note, the landlord did not prove that it effectively terminated the lease. The landlord’s conduct following the notice purporting to terminate the lease did not acknowledge the termination. Based on its ambiguous conduct, the court concluded the landlord did not establish that it effectively terminated the lease.

Since the landlord failed to establish that the debtor defaulted on the note, its default notice did not effectively terminate the lease, and the debtor still had a leasehold interest with a right to assume the lease (assuming it was able to satisfy the applicable Bankruptcy Code criteria for assumption). Accordingly the landlord’s request for stay relief was denied.

If a landlord wants to terminate a lease prior to a potential bankruptcy to prevent a debtor from having the ability to assume the lease, it should take clear, affirmative steps to do so. This desire is often in tension with a desire to continue to collect rents to the extent possible. Landlords should recognize that sometimes they have to make a choice. On the tenant side, it is good to remember that timely means timely. Being late by even a little bit can have significant consequences.

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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