Understanding the Rejection of Leases in Chapter 13 Cases

Posted by on Sep 25, 2011 in Chapter 13 Bankruptcy Issues | 10 comments

In chapter 13 cases, debtors may choose to reject leases to personal property, real property, or commercial property in the approrpiate cases.  These decisions can have a dramatic impact on a debtor’s plan payment provisions depending on the type of lease interest the debtor holds.

Personal Property Leases

Rejection of personal property is spelled out in 11 U.S.C. Section 365 of the Bankruptcy Code.   With respect to personal property, a lease is rejected if not assumed by the time of the chapter 13 plan confirmation hearing.  See Section 365(p)(3).  The effect of rejection leaves the lessor with a prepetition claim; whether that claim is secured or unsecured depends on the underlying contractual nature of the lease agreement.  For example, a car lease is an example of a lease for personal property.  If the lease is rejected, the car dealer will be entitled to take the car back and now has a breach of contract claim in the bankruptcy case.

Residential Leases

With respect to residential leases, any prepetition unpaid rent (rent that accrues before the bankruptcy case is filed) will become an unsecured claim in the chapter 13 case should the lease be rejected in bankruptcy.  And in essence, under §502(b)(6)(A), a landlord’s claim for lost rents after the lease is rejected is capped at the greater of 1 year’s worth of rent under a lease; or 15% of the remaining rent term but no more than the aggregate total of a three year rental period.  Finally, a lessor’s loss between the time the bankruptcy is filed and the debtor’s continued use of property post-petition may result in the lessor’s entitlement to reasonable fair market rental value.  This “use and occupancy” expense may be treated as an administrative expense meaning it must be paid as a priority claim (note chapter 13 cases require 100% repayment of priority claims).

Non-residential Leases

The rules for nonresidential leases (aka commercial leases) are unique to such types of leases and differ from the rules for residential leases.   A nonresidential lease is deemed rejected unless assumed within 120 days after the time the bankruptcy case is filed subject to 365(d)(4) of the bankrutpcy code.   However, if a plan is confirmed earlier, the lease must be assumed by that time unless a court extends the 120 day period.  Section 365(d)(4) states that the commercial property is subject  to surrender to a lessor after rejection.

For both residential and non-residential leases, a landlord carries the burden to demonstrate the damages resulting from rejection or termination of the lease.  “Upon such showing, the landlord’s allowable claim is limited to the formula described in section 502(b)(6)(A) plus, under subparagraph (B) of that section, any unpaid rent that was due under the lease, without acceleration, on the earlier of the dates described in subparagraph (A).”  Collier on Bankruptcy 502.03[7][c] (Alan N. Resnick & Henry J. Sommer eds.), 16.

For debtors in chapter 13 facing possible lease rejection claims, contact JCH Law Firm at 800-371-5523.  We have the experience in chapter 13 cases to properly guide our clients through the bankruptcy process.  For creditors, contact us if you need assistance maximizing your claims in bankruptcy.

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