By Wojciech F. Jung and Lowell D. Plotkin
Given the spate of bankruptcies filed over the past few years, including by large-scale tenants, and the tenuous financial condition of big-box retailers, it’s important for landlords and tenants to understand the benefits and limitations of bankruptcy protection as it relates to a bankrupt tenant’s leasehold interest. When it comes to lease termination, bankruptcy courts look to state law to determine the debtor’s property rights at the time of filing for bankruptcy protection. Therefore, even as between New York and New Jersey, the state substantive laws differ as to when a lease is considered terminated and thus outside the debtor’s ability to assume or sell it.
New York: “Unexpired” versus “Terminated” Leases and Warrants of Eviction
New York courts have long held that the issuance of a warrant of eviction in state court pre-bankruptcy proceedings terminates the landlord-tenant relationship. However, until that warrant is executed, the tenant retains a possessory (or equitable) interest in the premises (although the landlord-tenant relationship is deemed to no longer exist) and the automatic stay of the bankruptcy court applies to such interest, preventing the landlord from evicting the tenant without court permission. Furthermore, an unexecuted warrant of eviction may be vacated by a court for good cause.
However, the question of whether a lease is “unexpired” for the purposes of a debtor seeking relief under the Bankruptcy Code – which obligates the debtor to timely perform all of its obligations under any unexpired lease of nonresidential real property arising from and after the order for relief – remained ambiguous. The Court of Appeals for the Second Circuit recently addressed this issue and held that where a landlord obtains a warrant of eviction but does not execute that warrant prior to the tenant’s bankruptcy filing, the lease is deemed “unexpired” under the Bankruptcy Code. The Second Circuit reasoned that, although a warrant of eviction nominally terminates a lease, such lease is deemed “unexpired” until execution of the warrant and the corresponding quashing of the tenant’s residual statutory right to reinstate the lease. Furthermore, just because a lease is “unexpired” does not mean that the debtor can assume and assign the lease or that the landlord is entitled to rental payments and other costs for the post-petition period; the lease for which a warrant of eviction is issued pre-petition may not be assumed absent the tenant’s reinstatement of the lease in state court. It remains unclear whether a “terminated” yet “unexpired” lease should be treated as presumptively rejected by the bankruptcy trustee or whether the trustee should be required to affirmatively reject it in order to avoid liability for rent and other costs.
New York: Terminating the Lease by its Terms
While many landlords use the judicial process when terminating leases, others rely on the express terms of the lease because New York’s common law (unlike New Jersey’s, for example) looks favorably upon the express terms of the underlying lease. While forfeitures are anathema to New York courts, a lease may be terminated under New York law by operation of a conditional limitation (i.e., the landlord sending the defaulting tenant a notice of termination stating the lease will be deemed terminated upon a specified date, after the mere lapse of time, due to tenant’s default). The courts note that any such termination must be implemented in strict accordance with the underlying lease and differs from leases that provide the landlord with an option to terminate the lease if a default occurs. While the difference in the required wording of the lease may be subtle, it’s critical to both a landlord and a tenant because it may be determinative as to whether the bankrupt tenant retains a leasehold interest in the applicable premises or solely an equitable, possessory interest in the premises.
New Jersey: A Bright-Line Rule
In contrast to New York, New Jersey is clear. Judgment for possession terminates a nonresidential lease, not the issuance of the warrant for removal, because the New Jersey Anti-Eviction Act enables the tenant to cure a default in rent payments at any time on or before the entry of a final judgment. Even if a commercial nonresidential lease provides that the landlord may terminate the lease upon a certain number of days’ notice in the event of tenant default, termination will not be effective if tenant files for bankruptcy prior to a final judgment being entered in favor of the landlord. Consequently, it’s imperative that a New Jersey commercial landlord pursue judicial remedies in state court expeditiously if the goal is to terminate a lease prior to a tenant’s anticipated bankruptcy.
Conclusion
Tenants – insolvent or not – can maintain leasehold interest even after default, regardless of what the lease states. States vary regarding a debtor’s ability to assume and assign the lease and the landlord’s entitlement to post-petition administrative rents. Given the evolution of our economy and consumers’ shopping patterns, drafting clear lease provisions and expeditiously seeking judicial remedies after a tenant’s default is paramount.
Wojciech Jung is Counsel in Lowenstein Sandler’s Bankruptcy, Financial Reorganization and Creditors’ Rights Departmetn, and Lowell Plotkin is Counsel in Lowenstein Sandler’s Real Estate Department.
