Lease Debt Arises at Signing for Preference Analysis

By: Marissa Gross

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Recently, in Midwest Holding # 7, LLC v. Anderson (In re Tanner Family, LLC),[1] the Eleventh Circuit held that a debt on a lease agreement is incurred at the time of signing and not when the rental payments become due. Under section 547(b) of the Code, a bankruptcy trustee can avoid “any transfer of an interest of the debtor in property” provided the transfer meets five elements.[2] Since one of those elements requires that the payment sought to be avoided must be “for or on account of an antecedent debt owed by the debtor before such transfer was made,” determining when a debt is incurred is essential to the analysis.[3]

 

In In re Tanner Family, LLC, the debtor, Tanner Family, LLC, and the creditor, Midwest, entered into a lease agreement whereby the debtor would lease space from the creditor for five years. Under the terms of the lease rent was payable on the first day of each month.[4] Approximately two and a half years into the lease, the parties executed a Lease Termination Agreement. Tanner Family, LLC paid a lump sum and exited the premises at the end of the month. Within ninety days of paying the lump sum, Tanner Family, LLC, filed a chapter 11 bankruptcy. The court appointed a trustee, Anderson, who brought an adversary proceeding to recover the debtor’s lump sum payment as a preferential transfer under section 547(b) of the Code.[5]

 

The only 547(b) element in dispute was 547(b)(2), which concerns whether the payment was made on account of an antecedent debt.[6] The trustee claimed the Lease Termination payment was made on account of an antecedent debt because the debt was incurred at the time the lease was signed. However, the creditor, Midwest, claimed the payment was not made on account of an antecedent debt because no debt existed when the debtor made the Lease Termination payment, because a debt does not incur until the money is “legally collectible.” Midwest contended that under Georgia law, where the lease was created, rent is not legally collectible until the first day of each month, when each rental payment becomes due.[7] Thus, the central question under section 547(b)(2) is when the debt was incurred.[8]

 

The Code does not define when a debt is incurred, so the court was required to employ its own method of interpretation to provide an appropriate definition.[9] The court looked to other relevant terms that are defined under the Code[10] and noted that “debt” means “liability on a claim”[11]and, further that “claim” means “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is . . . matured, unmatured, disputed, undisputed, secured, or unsecured.”[12] From this the court deduced that “debt” covers both matured and unmatured claims.[13] In light of these definitions, “the term ‘debt’ is sufficiently broad to cover any possible obligation to make payment.”[14] As such the court concluded a debt is incurred at the time a lease is signed because, as of that date, the creditor has an unmatured claim against the debtor.[15]

 

Other courts have reached a different conclusion from the In re Tanner Family, LLC court on the issue of when a debt is incurred.[16] For example, the Bankruptcy Court for the Southern District of New York held that the debt on a lease agreement arrises periodically and not at the time the lease agreement is signed.[17] Additionally, the court further drew a distinction between rental payments and “other types of longer term debt” when determining when the debt is incurred.[18] The court noted that the debt on a rental payment is incurred when the payment becomes due, but the debt on other types of longer-term agreements can be treated differently.[19] The Bankruptcy Court for the Southern District of New Yorkinterpreted “debt” narrowly, whereas the In re Tanner Family, LLC court interpreted “debt” broadly.  That difference is important because it means that these cases could be decided differently depending on what circuit the case is decided in and what interpretation the court chooses to employ.

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