§ 28.02 Principal Bankruptcy Code Sections and Rules Applicable to Commercial Leasing Transactions

• Jurisdiction: United States
• Publication year: 2022

§ 28.02 Principal Bankruptcy Code Sections and Rules Applicable to Commercial Leasing Transactions

[1]—Introduction

A voluntary bankruptcy case is commenced by the filing of a petition. The filing results in the entry of "an order for relief." Involuntary cases are different. They are commenced by the filing of a complaint, followed by service of a summons with such complaint.¹ In an involuntary case, an "order for relief" is not entered when the case is filed; rather, it is entered either if the "alleged" debtor converts the involuntary case to a voluntary case thereby becoming a debtor, or if the bankruptcy court determines that the statutory requirement for sustaining an involuntary petition have been satisfied by the petitioning creditors.

The principal Bankruptcy Code sections governing the rights of commercial landlords and tenants are Bankruptcy Code §§ 362, 363, 365 and 541.² Section 362(a) of the Bankruptcy Code provides for the automatic stay of collection efforts, effective upon the filing of most voluntary bankruptcy cases.³ Section 362(b) lists exceptions to the automatic stay, while § 362(d) through (j) cover the process for obtaining relief from the automatic stay and related procedural matters.⁴ Bankruptcy Code Section 363 governs the sale, use, and other disposition of a debtor's interest in property, including property that may be located in office space or other commercial leasehold occupied by a debtor.⁵

Section 365 of the Bankruptcy Code governs executory contracts and unexpired leases, including leases for nonresidential real (commercial) property, e.g., office leases. Such leases may be "assumed" or "rejected" by a trustee in a Chapter 7 or 11 case, or by a debtor-in-possession exercising the authority of a trustee to assume or reject in a Chapter 11 case.⁶ If a lease is assumed by a tenant, the tenant retains its leasehold interest; if rejected, the tenant will lose its leasehold interest. However, upon rejection, the tenant is relieved from its obligations to perform as tenant.⁷

• Bankruptcy Code Section 541provides the statutory definition of "property estate." The property included in the definition of "property of the estate" is central to the function of the Bankruptcy Code and the applicability of many of its provisions. For example, an unexpired office lease only is subject to the effect of the automatic stay of Section 362 and the provisions of Section 363 and Section 365 of the Bankruptcy Code, if the lease in question is "property of the [bankruptcy] estate" of a debtor.⁸ Every office lease or other commercial lease with a remaining "term," to which a debtor is a party, is property of such debtor's estate and an "unexpired lease" subject to the provisions of the Bankruptcy Code. Under the Bankruptcy Code, however, a nonresidential real property lease receives special treatment that has major consequences for a debtor/tenant. Pursuant to Sections 362(b)(10), 365(c)(3), 365(d)(4)(A) and 541(b)(2) of the Bankruptcy Code, if a lease for nonresidential real property was terminated before a bankruptcy filing so that the debtor no longer has a property interest in such lease, then Sections 362, 363 and 365 largely are inapplicable to the lease.⁹

[2]—Bankruptcy Concepts

[a]—Property of the Estate

The court in which a bankruptcy case is commenced obtains exclusive jurisdiction over any and all property of the estate.¹⁰ Bankruptcy Code Section 541(a)¹¹ provides that property of the estate is composed of all of the following, "wherever located and by whomever held:"

(1) all legal and equitable interests of the debtor in property as of the commencement of the case;
(2) certain interests of the debtor and the debtor's spouse in community property as of the commencement of the case;
(3) any interest in property that the trustee recovers under enumerated provisions of the Bankruptcy Code;
(4) any interest in property preserved for or transferred to the estate under Section 510(c) (equitable subordination) or Section 551 (preservation of avoided transfer);
(5) certain interests in property acquired by the debtor or to which an entitlement arises, within 180 days after filing, by bequest, devise, inheritance, property settlement, divorce decree, life insurance policy or death benefit plan;
(6) proceeds of any of the above, except for post-petition wages in a Chapter 7 case; and
(7) property that the estate acquires after commencement of the case.

Although the term "property of the estate" for bankruptcy purposes is defined in Section 541 of the Bankruptcy Code, the nature and extent of a debtor's interest in property is determined under applicable nonbankruptcy law (state, federal, or foreign), including local real estate law affecting office leases.¹² However, whether a property interest is estate property under Section 541 is determined by application of federal bankruptcy law.¹³

Property of the estate includes non-leviable or even nontransferable rights of a debtor.¹⁴ This is true notwithstanding that these property rights may not fall within more traditional or common law concepts of property, which usually encompass physical property, claims to property and causes of action. For example, the broad statutory language of Section 541 encompasses the tax attributes of a debtor.¹⁵ Undoubtedly, a debtor's interest, as tenant under an office or other commercial lease is a property interest, subject to all of the rights and burdens imposed on such interests under Sections 541, 362, 363 and 365 of the Bankruptcy Code.¹⁶

[b]—Exclusions from Property of the Estate

A bankruptcy estate includes only property in which a debtor has an interest. The estate's interest in specific property can be no broader than the interest of a debtor in such property, e.g., his or her share of the property.¹⁷ Exclusions from property of the estate are listed in Section 541(b) of the Bankruptcy Code. Of specific interest with respect to office leases and other commercial leases is Section 541(b)(2), which states that property of the estate does not include:

"any interest of the debtor as a lessee under a lease of nonresidential real property that has terminated at the expiration of the stated term of such lease before the commencement of the case under this title, and ceases to include any interest of the debtor as a lessee under a lease of nonresidential real property that has terminated at the expiration of the state term of such lease during the case."

[3]—Claims

The term "claim," as used in the Bankruptcy Code, means any right to payment, even if the right is not reduced to judgment and is unmatured, unliquidated, contingent or disputed.¹⁸ For example, a right to equitable relief for breach of "performance" may constitute a claim under the Bankruptcy Code, even if the right to such equitable relief is not reduced to judgment and is unmatured, unliquidated, contingent and disputed.¹⁹ Thus, a commercial landlord may hold a variety of claims when its tenant becomes a debtor under the Bankruptcy Code, including, for example, liquidated claims for unpaid pre-bankruptcy rent, unmatured claims for the balance of the rent reserved by the commercial lease, and disputed claims for damages allegedly caused by the tenant/debtor to the leasehold.

Certain types of equitable relief will not constitute a "Claim" as such term is defined by the Bankruptcy Code. The only time equitable relief will give rise to a claim under the Bankruptcy Code is when a right to payment is an alternative remedy for the wrong that has given rise to the right to equitable relief.²⁰ A party may possess a claim under the Bankruptcy Code even if, under applicable nonbankruptcy law, a cause of action has not yet accrued.²¹

Generally, claims are satisfied under the Bankruptcy Code in accordance with the "absolute priority rule."²² In the broadest sense, for purposes of distributions of estate property, the "absolute priority rule" means that secured claims are paid first, unsecured claims next and equity interests last. There are certain claims and interests afforded priority treatment within these three major categories of claims. For example, a first lien creditor is paid before a second lien creditor and a claim for rent accruing during the administration of a bankruptcy case is paid (to the extent funds are available) before most other unsecured claims.²³ Generally, equity interests receive no recovery until all claims, whether they are general unsecured claims or claims entitled to a priority, are paid in full.

The specific provisions of the Bankruptcy Code creating a priority scheme (most notably Sections 503(b),507(a) and 726(a) apply only to unsecured claims. Priorities among secured claims and liens generally are governed by applicable nonbankruptcy law.²⁴ The highest priority unsecured claim cannot be paid out of secured creditor's collateral, until such secured creditor has been paid in full, the bankruptcy court surcharges the secured creditor's collateral has agreed to "carve out" payments from its collateral for the benefit of junior creditors, including unsecured creditors, whether the claims they hold are priority claims, or basic general unsecured claims.²⁵ Thus, with respect to the office leases and other commercial leases, rent accruing during the pending of bankruptcy case cannot be paid out of a tenant's accounts receivable (which is cash collateral, subject to a lenders interest) without the consent of the secured creditor or a court order authorizing and directing such payment.²⁶

A debtor/tenant must timely perform its obligations under a lease of nonresidential real property, including an office lease, until such time as the lease either is assumed or rejected.²⁷ Although not expressly set forth in the Bankruptcy Code, many courts construe this directive as a grant to lessors of a de facto "super-priority" claim, requiring payment of rent during the pendency of the bankruptcy case as and when a periodic payment is due.²⁸...