Landlord Tries “To Be an Optimist About This” In Arguing Sections 365 and 503 Apply to Guarantor of Lease Obligations

Contributed by Elisa Lemmer
Bastille’s hit song, Pompeii, most likely was not written about the chapter 7 case of Daniel Green and his wife.  Its lyrics, however, are a good metaphor for the outcome of one landlord’s efforts to recover an administrative expense against a debtor who had guaranteed the lease obligations of a non-debtor tenant.  Unfortunately for the landlord, “many days fell away with nothing to show” as the United States Bankruptcy Court for the Southern District of Georgia held in In re Green that the landlord could not recover an administrative expense against the debtor-guarantor and that, instead, the landlord’s claim was a general unsecured claim subject to treatment under section 502(b)(6) of the Bankruptcy Code.
In In re Green, prepetition, Statesboro Mall LLC (the landlord) entered into a lease with Crooked Run Investments LLC (the tenant) pursuant to which the landlord agreed to lease to the tenant a certain parcel of land on which the tenant intended to operate an ice cream shop.  In conjunction with the execution of the lease, the debtor entered into a guarantee agreement with the landlord under which he personally guaranteed the tenant’s prompt payment and performance under the lease.
Before the lease term expired, the tenant closed its business and vacated the premises.  The landlord sent a default letter to the tenant, but the tenant did not cure its default under the lease.  Shortly thereafter, the debtor filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code.  During the pendency of the bankruptcy case, the debtor did not occupy or use the leased property.  Following the debtor’s discharge, the tenant surrendered its interest in the lease to the landlord, and shortly thereafter, the landlord was able to relet the property for the remaining term of the lease.
Subsequently, the landlord filed two documents with the bankruptcy court: 1) a proof of claim for rejection damages under the lease and 2) an application for payment of an administrative expense for postpetition rent under sections 365(d)(3) and 503 of the Bankruptcy Code.
Section 365(d)(3) of the Bankruptcy Code requires “the trustee [to] timely perform all of the debtor’s obligations” (except those specified in section 365(b)(2)) arising postpetition under any unexpired lease of nonresidential real property pending assumption of rejection of the lease.  The landlord contended that section 365(d)(3) was applicable because section 365(d)(3) does not specify that the debtor must be the landlord or tenant under the unexpired lease of nonresidential real property and contains the word “any” when referring to unexpired leases.  Consequently, the landlord argued that section 365(d)(3) applies even where the debtor is a just a guarantor of an unexpired lease of non-residential real proerty.
The bankruptcy court rejected the landlord’s section 365 argument outright.  It observed, among other things, that section 365(d)(3) applies only to leases of the debtor, focusing on the language contained in section 365(a) of the Bankruptcy Code, which allows the trustee or debtor-in-possession to “assume or reject any executory contract or unexpired lease of the debtor” and observing that the Bankruptcy Code does not allow a debtor to assume leases or contracts to which it is not a party.  Because the debtor was not a party to the lease, the court concluded that the lease was not “an unexpired lease as to the Debtor.”  In addition, the bankruptcy court reasoned that even though the debtor guaranteed the tenant’s performance, the debtor’s liability arose under the guarantee – not an unexpired lease under section 365.  Further, the court observed that the Bankruptcy Code grants administrative expense priority to the payment obligations under an unexpired lease “while the trustee or debtor-in-possession decides whether to assume or reject the lease,” but nothing in the Bankruptcy Code or the guaranty granted the debtor, as a guarantor of the lease, the right to assume or reject the lease – or any other right in the lease, for that matter.  The court concluded its section 365 analysis by noting, axiomatically, “Section 365 simply does not apply to contracts or leases under which the debtor has no rights.”
The court similarly rejected the landlord’s request for payment of the postpetition rents as administrative expenses of the debtor’s estate under section 503 of the Bankruptcy Code.  Section 503 of the Bankruptcy Code allows an entity to receive administrative priority for certain expenses from a debtor’s estate.  Quoting In re Episode USA, Inc., a decision issued by the United States Bankruptcy Court for the Southern District of New York, in which that court considered similar facts to those in Green, the bankruptcy court in Green observed that to be entitled to administrative priority under section 503, a claim, “must have arisen from a transaction with the estate or consideration must have been given to the estate, and the debt must have benefited the estate.”  The court further noted that even where courts have adopted an expansive view of section 503, they limit administrative expense status to those claims that arise in connection with the debtor’s postpetition transactions.  The court concluded that the debtor did not receive any benefit from possession of the leased property postpetition, and the rents due thereunder could not be considered the “actual, necessary costs and expenses of preserving the estate.”
Ultimately, the court concluded that the landlord was nothing more than a general unsecured creditor of the debtor and that its claim was one that would be “properly addressed” under section 502(b)(6) of the Bankruptcy Code (which caps a landlord’s general unsecured claim for damages).  The landlord’s application for payment of administrative expenses was denied.
After reading the Green decision, landlords may ask, “How am I gonna be an optimist about this?” But the answer is that the Green decision doesn’t break any new legal ground, other courts have decided similarly to the court in Green, and “if you close your eyes…it almost feels like you’ve been here before.”