In re Mallett, Inc., No. 21-11619, 2023 Bankr. LEXIS 3008, 2023 WL 8885916 (Bankr. S.D.N.Y. Dec. 22,2023)
Background on Executory Contracts
For some background, a lease is considered an executory contract. An executory contract is a contract between a debtor and another party in which each party still has important performance obligations remaining. Thus, if either side ceased performing under the contract, such action would constitute a breach of contract.
Bankruptcy allows the debtor to reject executory contracts. Rejection constitutes a breach allowing the lessor/landlord to file a rejection claim to be considered a pre-petition claim. Per the Bankruptcy Code, rejection claims are capped at the greater of a) one year’s worth of payments commencing on the date of termination or the date of bankruptcy or b) 15% of the amount due not to exceed three years of the remaining term.
Typically, a debtor will reject unwanted leases at or about the time of bankruptcy as payments due under the executory contract after the filing of a bankruptcy can give rise to an administrative claim which carries the highest priority in a Chapter 11 proceeding. The issue determinative of an administrative claim under these circumstances would be whether the debtor derived some benefit from the lease.
In re Mallett and Lease Rejection
In Mallet, the debtor, as a tenant, had executed a 25-year lease. It eventually closed its doors and subleased the space. The subtenant defaulted on the sublease and the parties negotiated a $3 million dollar settlement that terminated the sublease. At or about the same time, the landlord had sued the debtor and obtained summary judgment of $1.2 million in unpaid rent. Two weeks later the debtor filed for bankruptcy.
The debtor eventually filed a motion to reject the lease. The issue before the court was whether rejection could be retroactive as of the petition date. The debtor argued that since it had attempted to surrender the premises and the landlord had refused, technically the lease had terminated. The court found that the lease had not been terminated pre-petition, but approved rejection of the lease.
The next issue to be addressed was whether the rejection would date back to the petition date. Noting that the debtor had surrendered the premises and the landlord had made no attempt to mitigate its damages, the court ruled the rejection was effective as of the date of bankruptcy.
The next issue was the determination of the rejection damages. The landlord and debtor agreed that the one-year calculation was the applicable time period to determine the rejection claim. Whereas the debtor argued that the rejection claim should be as of the date it surrendered the premises to the landlord — the landlord argued the rejection claim should be as of the petition date which would allow for a greater rejection claim.
Because the landlord refused surrender and did little if anything to mitigate damages, the court ruled that the date of the attempted surrender was the applicable date to determine the one-year cap.
So, perhaps the lesson here is that a landlord needs to show an element of good faith. When a tenant surrenders the premises, the landlord does not necessarily have to terminate the lease but the landlord needs to accept the surrender and start mitigating its damages.
