By J. Henk Taylor

1 With economic recovery slow to take hold, 2010 willlikely see an uptick in the number of business bankruptcyfilings. This is especially true for troubled retailers wholimped into the all-important Christmas shopping seasonlast year hoping to stave off a Chapter 11 filing. Commerciallandlords, some of whom have already suffered vacanciesthrough the bankruptcy filings of national retailers in 2008and 2009 ( , Linens N Things, Circuit City andHollywood Video), likely will receive more notices ofbankruptcy filings by their a tenant files Chapter 11, a commercial landlordconfronts a number of and foremost, thelandlord is concerned about getting paid its rent. Thelandlord also faces uncertainty about whether the tenant willstay in the space or close its doors. If the tenant decides tovacate the space, the landlord will want to maximize itsrecovery on any claim it may have in the tenant s for commercial landlords, Congress has builtinto the Bankruptcy Code a number of protections for a landlord s basic rights and remedies under theBankruptcy Code is critical to both the landlord and itscounsel when a notice of bankruptcy arrives in the vs.

2 Rejection of a LeaseWhen a tenant files bankruptcy with an unexpired lease ,the lease is put into legal limbo. On the one hand, unless anduntil the lease is rejected by the debtor, the debtor isrequired to timely comply with its obligations arising underthe lease after filing bankruptcy. On the other hand, throughthe power of rejection given to it under the BankruptcyCode, the debtor can get out of the lease Bankruptcy Code gives the debtor a breathing spaceto decide what it wants to do with the lease . This decisioncomes down to whether the debtor wants to assume or reject the lease . 11 365(a). If the debtor elects toassume the lease , the debtor agrees to be bound by the termsof the lease going forward. The debtor may continue tooccupy and use the leased space for the remainder of thelease term (including any renewal options in the lease ).

3 Butthe debtor is also required to comply with the lease ,including timely payment of rent, for the remainder of thelease the debtor no longer wants the leased space, the debtorwill likely reject the lease . By rejecting the lease , the debtoris relieved from having to further perform under the leaseafter the date of rejection. The debtor must then surrenderpossession of the premises to the of a LeaseIf the debtor decides to assume a lease , the debtor mustfile a motion in the bankruptcy case and satisfy certaincontinued on page 22By J. Henk TaylorARIZONA BUILDINGSSUMMER 2010 I2122 IARIZONA BUILDINGSSUMMER 2010requirements before the court can authorize most important of these requirements is that thedebtor must promptly cure all defaults under the lease . 365(b)(1)(A). This means the debtor must pay thelandlord all pre and post-petition rental arrearages due underthe lease .

4 The debtor must also provide adequate assuranceof future performance under the 365(b)(1)(C). Normally a debtor provides such adequateassurance by showing the debtor is current on its rentpayments and has sufficient income to make most cases, the debtor s assumption of the lease is agood result for a landlord. The landlord will get paid its past-due arrearages immediately as part of the debtor s cure , if a lease is assumed, any futuredefaults under the lease will give rise to a priorityadministrative claim for the landlord in the bankruptcy priority claim gives the landlord greater assurance that itwill get paid its rent in the future. Finally, assumption of thelease protects the landlord from any future preference claimsby the bankruptcy estate seeking to claw back payments madeto the landlord under the lease prior to the bankruptcy many markets today, the increasing vacancy rate forcommercial properties means a debtor tenant can often findcheaper space to operate its business.

5 This may tempt a tenantto reject a pre-petition lease with an above-market rental ratein favor of moving into new space at a lower rental landlord should be pro-active at the outset of a tenant sbankruptcy to determine whether the tenant intends toreject the lease . Landlords and tenants should not treat theexisting lease as a static document that presents the tenantwith a take it or leave it proposition for assumption. Eventhough a tenant is in bankruptcy, the landlord and tenantmay negotiate modifications to the lease . If the tenant voicesconcern about the current rent or termof a lease , the landlord should entertainre-negotiating the lease to entice thetenant to assume a modified lease thatkeeps the tenant in the property andpaying of a LeaseA debtor may elect to assume a leaseeven though the debtor has nointention of staying in the leased is because the Bankruptcy Codeallows a debtor to assume and then assign an unexpired lease to a thirdparty.

6 Once a lease is assigned, theassignee steps into the debtor s shoes asthe tenant and the debtor is relievedfrom any further performance underthe debtor can do this despite the fact that leases normallycontain clauses prohibiting or restricting assignment by atenant. Such anti-assignment clauses are nullified by theBankruptcy Code. 11 365(f )(1). Courts interpretSection 365(f )(1) broadly and apply it to clauses other that donot, on their face, address assignment. For example, a clausethat allows the landlord to terminate a lease upon a change incontrol of the tenant is an indirect restriction on assignmentthat is negated by Section 365(f )(1). See In re Crow WinthropOperating Partnership, 241 1121 (9th Cir. 2001).As a result of Section 365(f )(1), debtors (and bankruptcycourts) can effectively re-write certain terms of a lease uponassignment.

7 And debtors will push the envelope in usingSection 365(f )(1) to eliminate unfavorable lease terms onassignment. But this power to eliminate lease terms islimited. Generally courts will not allow a debtor to excise alease clause under the guise of Section 365(f )(1) if thatclause is material to the lease and economically significant to the landlord. Thus a clause that allows a landlord toterminate a lease if the tenant does not maintain a certainaverage volume of sales is material, economically significantand cannot be excused under Section 365(f )(1) even thoughsuch a term hampers assignment of a lease . In re JoshuaSlocum, Ltd., 922 1081 (3rd Cir. 1990).Fortunately, the Bankruptcy Code affords someprotection to landlords facing an assignment of a lease by adebtor. Most notably, in order to assign a lease , the debtormust first be able to assume the lease .

8 Thus the debtor mustpromptly cure any arrearages under the lease . The debtormust also provide adequate assurance of future performanceby the assignee under the lease . 11 365(f )(2)(B).This requirement gives the landlord a chance toinvestigate and potentially object to the creditworthinessof a proposed from page 21 RejectionWhereas the Bankruptcy Code places specific conditions ona debtor s ability to assume (and assign) a lease , no suchrestrictions apply to a debtor s decision to reject a lease . Amotion to reject a lease is judged under a business judgment standard; and courts rarely second-guess a debtor s decision toreject a it may be little comfort to the landlord, a debtor srejection of a lease will give the landlord a claim in thebankruptcy case. If the debtor ends up rejecting the lease (eitheraffirmatively or by default by failing to timely assume the lease ),then the timing of the rejection will impact the nature of thelandlord s claim in the bankruptcy case.

9 A landlord on arejected lease will have a pre-petition, non-priority claim for thereserved rent due under the lease following the date of 502(g). Given that reserved rent claims arepotentially large and threaten to swamp other unsecured claimsin a case, the Bankruptcy Code places a cap on such rejectiondamages claims. 11 502(b)(6).Debtors will seek to reject a lease as of a date that minimizesits exposure to administrative rent liability under Section365(d)(3). The critical point is that a lease is not rejected,thereby stopping the administrative rent clock, until thebankruptcy court enters an order approving the , once a debtor decides to reject a lease , the debtor willfile a motion and seek to have it heard as quickly as possible soas to have the lease rejected prior to the next due date for , most courts strictly construe Section 365(d)(3) s mandateto timely pay the full amount of any payment due prior torejection.

10 So if a rental payment is due on the first of a month,and the court s order rejecting the lease is entered the next day,then the landlord is entitled to an administrative rent claim forthe full month even though the lease was rejected on the secondday of the month and the debtor has vacated the property. In reKoenig Sporting Goods, Inc., 203 986 (6th Cir. 2000).Landlords need to carefully review motions to reject to makecertain they get what they are entitled to under the BankruptcyCode in the way of an administrative rent claim. Becauseadministrative claims are usually paid in full while pre-petition,non-priority claims usually get cents on the dollar, anadministrative claim is often the landlord s best hope of gettingsome payment on a rejected business Chapter 11 cases involve at least onecommercial real estate smaller cases, a debtor sheadquarters lease can be both a critical asset and a significantburden to the debtor.