Rochelle's Daily Wire

If followed by other courts, a decision by Bankruptcy Judge Klinette H. Kindred of Alexandria, Va., could knock some debtors out of Subchapter V solely as result of liability on long-term leases.

In her June 14 decision, Judge Kindred distinguished a decision by Bankruptcy Judge Thomas J. Catliota of Greenbelt, Md., who held that the contingent liability on a lease is not counted in deciding whether the debtor has more than $7.5 million in debt. See In re Parking Mgmt., 620 B.R. 544 (Bankr. D. Md. 2020).

The debtor was a software developer who ran into bad times during the pandemic. With employees working from home, the debtor needed less office space. On filing in chapter 11 and electing treatment under Subchapter V, the debtor filed a motion to reject the office lease.

The rent owing throughout the remainder of the term of the lease was $14.4 million. The landlord moved to dismiss the case as a bad faith filing. Short of dismissal, the landlord wanted Judge Kindred to declare that the debtor was ineligible for Subchapter V, counting the remaining rent under the lease.

The debtor countered by saying that future rent was contingent on the filing date and that the lease claim shouldn’t be more than the capped rejection claim under Section 502(b)(6).

For Subchapter V eligibility, the outcome was controlled by Section 1182(1). It requires the debtor to have:

noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition. . . in an amount not more than $7,500,000 . . . not less than 50 percent of which arose from the commercial or business activities of the debtor.

Judge Kindred said that the parties found no cases “directly on point.” Parking Management was the closest. There, the debtor moved to reject leases alongside the filing of the petition. Evidently, lease-rejection damages would make the debtor ineligible for Subchapter V.

Because rejection was dependent on action by the court after filing, Judge Catliota held that the rejection claims were contingent and thus not included in the eligibility calculation.

Judge Kindred distinguished Parking Management for having only focused on rejection damages that were contingent. She said, “that does not mean this Court will ignore the Debtor’s existing pre-petition liability under the Leases in favor of post-petition events when determining eligibility.” Absent rejection, she said that the debtor would owe $14.4 million under the lease.

“In this case,” Judge Kindred said, liability on the lease arose before filing when the lease was executed. Therefore, she held that liability on the lease “must be considered noncontingent and liquidated,” making the debtor ineligible for Subchapter V. She also rejected the idea of counting only the capped lease claim.

Believing that other creditors would not benefit from dismissal, Judge Kindred revoked Subchapter V eligibility but allowed the debtor to continue under “regular” chapter 11.

Together with granting the debtor’s motion to reject the lease, Judge Kindred also denied the landlord’s motion to dismiss for a bad faith filing. She held that the landlord had not shown both subjective bad faith and objective futility, as required by the Fourth Circuit in Carolin Corp. v. Miller, 886 F.2d 693 (4th Cir. 1989).

On subjective bad faith, Judge Kindred found nothing wrong with a debtor who files bankruptcy to reject a lease and cap damages. On objective futility, she said that the debtor’s 100% plan may require “some tweaks” but “cannot find that the restructuring in this case is objectively futile.”

Questions

On signing a lease, is the lessee immediately liable under state law for all of the rent during the term of the lease? Or, is the lessee only liable each month for that month’s rent when the rent comes due?

If a debtor is current on a lease on filing a Subchapter V petition, is there any debt to count with regard to the $7.5 million cap for eligibility?

Is the debtor liable under state law for all remaining rent if the debtor was in default on filing? Or, is the debtor liable only for the amount in arrears?

If the debtor moves to assume and cure lease defaults, how much is there in lease liability? If the debtor moves to reject a lease, is Subchapter V liability based on the capped rent claim?