Commercial Landlords: Don’t Terminate That Defaulting Lease Yet!
Kegler Brown Creditors' Rights + Bankruptcy News May 19, 2016
Smart Summary for Commercial Landlords
- Understand that termination of a defaulting commercial lease may constitute a transfer of assets and a fraudulent conveyance in the event of a tenant bankruptcy.
- Evaluate the likelihood of a tenant bankruptcy before terminating a lease.
- Make a record that the lease has no value to the tenant or its creditors as of the date of termination.
- Take special precaution if terminating multiple leases for the same tenant at different locations.
- Consult with bankruptcy counsel if leases contain arguable financial value to creditors.
A landlord managing commercial property with a defaulting, financially shaky tenant wants to avoid involvement in the tenant’s bankruptcy because dealing with the defaulted lease in the bankruptcy court can be time-consuming and costly. In fact, termination of the lease prior to bankruptcy usually gives the landlord an advantage and is often a wise strategy. However, a recent decision of the federal Court of Appeals in Chicago warns that termination of the lease to recover possession may come with a price tag if it is later determined that the lease was a financially valuable asset of the tenant. The court held that a lease termination is a “transfer” of an asset of the debtor and, under bankruptcy law, the landlord may be liable in damages for a preference or fraudulent conveyance of that asset to the landlord resulting from the termination of the lease.
Great Lakes Quick Lube, which had leased several stores that provided oil changes and other automotive maintenance services, had negotiated termination of two of its leases 52 days before it declared bankruptcy. In the bankruptcy case, the Committee of Creditors brought a claim against the landlord for damages and contended that each lease had positive economic value because those stores were operating profitably. Consequently, the Committee claimed that the Debtor gave that value to the landlord upon voluntary surrender of the leases.
This decision is contrary to a number of prior cases in lower courts that held that pre-petition termination of a lease is not an avoidable transfer. The decision also failed to consider provisions of the Uniform Fraudulent Transfer Act, which states that a transfer is not voidable if it results from “termination of a lease upon default by the Debtor and the termination is pursuant to the lease and applicable law.” The appeals court sent the case back to the bankruptcy court for determination of the value of the property “transferred” to the landlord and whether the landlord had any defenses to the claims under preference or fraudulent conveyance law. It remains to be seen whether the landlord in Quick Lube will have to pay damages or not.
Lessons for Commercial Landlords
A landlord that is tempted to exercise its rights to terminate a commercial lease should evaluate whether the tenant could wind up in a bankruptcy proceeding. If there is a chance of this, consideration should be given to whether the lease could be a financially valuable asset. If so, a transfer could result in financial liability for a preference or fraudulent conveyance. A landlord should make a record that the lease has no financial value to the tenant or its creditors as of the date of termination. Where there are multiple leased sites, this evaluation should be done on a lease-by-lease basis. On the other hand, if some leases may have economic value and others do not, it may be best to document the termination of all the leases as a single event.
Ultimately, if the leasehold has any arguable financial value to creditors, a landlord should confer with experienced bankruptcy counsel and do a careful analysis of the costs and benefits associated with termination of the lease.
Official Committee of Unsecured Creditors of Great Lakes Quick Lube vs. T.D. Investments I, LLP United States Court of Appeals for the Seventh Circuit, Case No.: 15-2093