Monday, December 10, 2018

TENANTS OF REJECTED LEASES IN BANKRUPTCY MAY NOT HAVE TO PAY RENT

By Bill Siegel

When a landlord files bankruptcy and rejects a lease, the tenant has the right to remain in the premises.  Moreover, the tenant has the right to offset whatever damages it may have against the bankrupt landlord.

The Bankruptcy
In Revel Entertainment Group LLC v. Idea Boardwalk LLC (In re Revel AC Inc.),  17-3607 (3d Cir. Nov. 30, 2018), prior to the filing of the bankruptcy, the Debtor Revel and the operator of two nightclubs and a beach club, Idea (the “Operator”), had entered into a lease whereby they agreed to spend a combined $80 million to build the nightclubs with the Operator agreeing to kick in $16 million and the Debtor agreeing to pay the rest.  For obvious reasons, the Debtor was unable to fulfill its obligations once it filed bankruptcy. 

During the bankruptcy, the Debtor sold the casino and as part of the sale order, the Operator’s rights under the lease were carved out setting the stage for future litigation.  After the sales order was entered, the Debtor rejected the lease with the Operator.  The Operator elected to remain in the premises and further sought to recoup its damages arising from the landlord’s default and subsequent rejection of the lease.  In doing so, the Operator took the position that it had no obligation to pay any rent until it recouped all its damages.  The purchaser, in turn sought to evict the Operator.

Third Circuit Finding
The Third Circuit Court of Appeals agreed with the Operator.  It first noted that Bankruptcy Code Section 365(h)(1)(A)(ii) permits a tenant to retain whatever rights it may have under a lease including “the amount and timing of the payment of rent.”  It further noted that Bankruptcy Code Section 365(h)(1)(B) permits the tenant to offset the “value of any damage caused by the [debtor’s] nonperformance” against rent. 

Not only did the lease grant the Operator the right to recoup its damages but the Third Circuit found that there was a common law right of recoupment.  So, by being able to remain in the premises, the Third Circuit ruled that the Operator was entitled to offset the value of its damages, which in this case included its right to enforce the Debtor’s obligation to build out the nightclubs.  The net effect of this ruling allowed the Operator/tenant to remain in the premises rent free for at least until it had recouped the Debtor’s (or in this case, the purchaser’s) obligation to kick in $64 million.

Lesson for Landlords
The lesson from this ruling is that even when a bankrupt landlord decides to walk away from its obligations and reject its leases, the Bankruptcy Code has tenant-friendly provisions that allow the tenant to not only remain in the premises, but to also recoup its damages, which in some cases may entitle it to remain rent free.

 

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