Restructuring

Contributed by Dana Hall
A recent decision rendered by the United States District Court for the Southern District of New York suggests that a landlord that obtains a warrant of eviction prepetition, but is thereafter stayed from executing upon its warrant by the debtor’s bankruptcy filing, may not be entitled to postpetition rent.
In the chapter 7 case of In re Assoc. of Graphic Commc’ns, Inc., Judge Lifland of the United States Bankruptcy Court for the Southern District of New York determined that, because the prepetition warrant of eviction had terminated the lease, the debtor had no obligation to pay postpetition rent pursuant to section 365(d)(3) of the Bankruptcy Code.  On appeal, the district court affirmed the bankruptcy court’s decision.
Several months prior to filing its chapter 7 petition, the debtor in Graphic Commc’ns ceased business operations and stopped paying rent at its business premises.  The landlord locked the debtor out of the premises and ultimately obtained a judgment of possession and a warrant of eviction against the debtor.  Unfortunately for the landlord, the debtor filed its chapter 7 petition the following day, thereby staying the landlord’s efforts to execute upon the warrant.  Approximately two months after the petition date, the bankruptcy court, upon the landlord’s uncontested motion, modified the automatic stay to permit the landlord to execute on its warrant.  Having been unable to re-let the premises for three months (although presumably partly because of its own delay in moving for stay relief), the landlord requested payment of postpetition rent as an administrative expense pursuant to section 365(d)(3) of the Bankruptcy Code.  Because the bankruptcy court concluded that, under New York law, the lease had terminated upon the issuance of the warrant of eviction, it also concluded that the debtor in possession was not a party to an “unexpired lease” on the petition date and, therefore, did not have to comply with any postpetition obligations under the lease.
Judge Lifland distinguished two factually similar Southern District of New York cases upon which the landlord relied.  In In re P.J. Clarke’s Restaurant Corp., a New York state court had issued a summary judgment order granting the landlord possession of the premises, but the debtors filed their chapter 11 petitions before judgment was entered and the warrant of eviction was issued.  The United States Bankruptcy Court for the Southern District of New York, in P.J. Clarke’s, determined that the debtor’s lease constituted an “unexpired lease” and that, pursuant to section 365(d)(3) of the Bankruptcy Code, the landlord was entitled to receive rent at the contract rate until the lease was assumed or rejected.  The Graphic Commc’ns court found P.J. Clarke’s to be easily distinguishable because, in P.J. Clarke’s, the state court had not issued a warrant of eviction prior to the petition date, the debtor had taken affirmative steps to challenge the nonpayment proceeding and the state court’s summary judgment opinion, and the debtor had continued its operations on the premises.  In In re Sweet N Sour 7th Ave. Corp., similar to the facts in Graphic Commc’ns, a New York state court issued a warrant of eviction immediately prior to the petition date.  In Sweet N Sour, the United States Bankruptcy Court for the Southern District of New York also determined that the debtor’s lease had terminated prepetition.  In that case, however, the debtor was appealing from the state court judgment, and the bankruptcy court required the debtor, during such appeal, to pay all outstanding postpetition amounts owed and to stay current on postpetition rent going forward.
Both P.J. Clarke’s and Sweet N Sour involved chapter 11 debtors that had actively sought to reinstate their respective leases and appeal the warrants of eviction in the respective state courts.  Those debtors also remained in possession of the leased premises and continued operations at the premises.  The bankruptcy courts in those cases permitted the debtors to modify the stay and proceed with their state court appeals, contingent upon the debtors’ ongoing payment of postpetition rent to the landlords.  In contrast, Judge Lifland found that the Graphic Commc’ns debtor did not even have a “naked right to possession” because the debtor had ceased all operations on the premises, the landlord had locked the debtor out, and the trustee could not enter the premises without the permission of the building superintendent.  The court also noted that the lease expired by its own terms only three weeks after the petition date.  Moreover, it appears that the landlord could have avoided a two-month delay by seeking stay relief at the outset of the case.  The trustee may not have been prepared at the commencement date to determine whether to appeal from the state court judgment and may have sought to take advantage of the full 60-day period afforded by section 108(b) of the Bankruptcy Code to make that decision.  By acting more promptly, though, the landlord either might have achieved an earlier consensual modification of the stay or an agreement to pay the postpetition rent while the trustee decided what course to take.
If the debtor is still in possession of the leased premises and desires to assume the lease, it does appear that courts in the Southern District of New York will generally permit the debtor to continue to remain in possession and pursue a challenge to termination of the lease in exchange for continued payment of postpetition rent pursuant to section 365(d)(3) of the Bankruptcy Code.  Following the district court’s decision in Graphic Commc’ns, however, if a debtor’s lease is terminated prepetition and the debtor is no longer in possession of the leased premises, whether the debtor may challenge the state court judgment and whether the landlord may require postpetition rent remain uncertain.  What is clear is that prompt action by a landlord might avoid a delay and loss of value by the landlord.