Changing The Term Of a Lease from a Fixed Period to a Variable One Improves Odds In Bankruptcy
In In re Indiana Hotel Equities, LLC, 586 Bankr. 870 (Bankr. E.D. Mich) a tenant operated a hotel near the Indianapolis Airport upon land which it leased. The lease was for 72 years commencing in 1962 and ending on June 30, 2034. Pre-bankruptcy, the landlord obtained a state court judgment that the hotel operator had defaulted under the lease, and that the landlord had properly terminated the lease. That state court ruling was on appeal when, thirteen days later, the bankruptcy case was filed.
The landlord filed a motion for relief from the automatic stay, seeking permission to evict the tenant. Rather than a typical relief from stay motion, the motion at issue was based solely upon the argument that the Automatic Stay did not apply since, it argued, the stated term of the lease had expired pre-petition under §362(b)(10) of the Bankruptcy Code.
Section 362(b)(10) states that the Automatic Stay does not apply to:
"any act by a lessor of the debtor under a lease of nonresidential real property that has terminated by the expiration of the stated term of the lease before the commencement of or during a case under this title to obtain possession of such property".
The bankruptcy court ruled that the "stated term of the lease" means the calendar date specified in the lease as the end of the lease term. The landlord had argued that it should be the earlier date on which the lease had terminated under the terms of the lease or under non-bankruptcy law.
The court responded:
"[S]ection 2 of the Lease as amended by the Lease Amendment, explicitly and unambiguously defines the 'Term' of the Lease as 'a term of seventy-two (72) years, commencing July 1, 1962, and ending on June 30, 2034.' There is no language in the Lease's definition of the lease's 'Term,' or anywhere else in the Lease that limits that stated term of the Lease by the [landlord's] right, set forth in Section 15 of the Lease, to 'cancel' the Lease 'in its entirety' by written notice, upon the Debtor's default. Rather, Section 15 of the Lease sets forth grounds upon which the [landlord] could end the Lease early, before the expiration of its stated term."
This language of the court strongly suggests that the outcome might have been different had the termination and default provisions of the lease been drafted more flexibly. For example, instead of a fixed date, the "term" of the lease might have been defined as "that period during which the debtor is not in default under the lease but no later than [insert ultimate end date]." Another plausible alternative would have been "all time periods prior to entry of a court ruling determining that the lease has expired, but not later than [end date]." Further, instead of giving landlords the right to cancel the lease early, default provisions should instead just allow landlords to give notice that the lease has already terminated.
Key to the court's ruling was the fact that the state court judgment was on appeal when the bankruptcy case was filed. On the one hand, the bankruptcy judge determined that the ruling of the state court (that the lease terminated pre-petition) was binding under the doctrine of collateral estoppel. On the other, the bankruptcy court discussed why a relief from stay motion might have been denied:
"The complexity of the stay relief question arises, in part, because the Debtor has an appeal pending in the Indiana courts … . If the debtor were to lose possession of the Property now, that could quickly ruin the Debtor's hotel business and destroy any chance of a successful reorganization, so that any later success by the Debtor in its state court appeal would be a useless victory. But if the automatic stay remains in place, the IAA [Landlord] may have valid arguments that some form of adequate protection must be ordered, to protect its ownership interest in the Property while the Debtor's State Court appeal proceeds."
This last quote challenges the conventional assumption that bankruptcy is not to be used as an alternative to posting an appellate/supersedeas bond. It also raises the possibility that adequate protection payments to a landlord may be based on current market rental rates, and not the presumably lower rate provided in the lease (after all, that lease had terminated). It further limits the effect of collateral estoppel in a way that is hard to reconcile with its ordinary meaning. On the other hand, because 11 U.S.C. §541(b)(2) states that an interest of the debtor as a lessee under a lease "that has terminated at the expiration of the stated term of such lease" is not property of the bankruptcy estate, the implication is that other leases (even those that have terminated pre-petition for other reasons) remain property of the estate. Another lesson of the case is just how significant the filing of an appeal pre-petition can be, regardless of state law limiting an appeal's impact on doctrines of issue preclusion.