Terminator II — Second Circuit Revisits the Distinction Between Terminated and Expired Leases Under Section 365(d)(3)

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Revisiting an issue it previously had explored under Vermont law, the United States Court of Appeals for the Second Circuit recently held in Super Nova 330 LLC v. Gazes that, under New York law, when a landlord obtains but does not execute a warrant of eviction prior to a tenant’s bankruptcy filing, the lease in question is “unexpired” for purposes of section 365(d) of the Bankruptcy Code.

Super Nova, the landlord, rented a commercial building located in New York to the Association of Graphic Communications, Inc. pursuant to a non-residential lease agreement set to expire February 28, 2007.  In the summer or fall of 2006, AGC ceased business operations and stopped making rent payments under the lease.  Super Nova began a nonpayment proceeding against AGC in New York City Civil Court and subsequently won a default judgment of possession and was issued a warrant of eviction on February 1, 2007.  The day after the warrant was issued, AGC filed a voluntary chapter 7 petition that automatically stayed all actions against the company and prevented Super Nova from executing its warrant.

Super Nova successfully sought to lift the automatic stay so that it could execute its warrant of eviction.  On April 24, 2007, it finally executed its warrant and obtained both legal and actual possession of the property.  A little less than two years later, on January 30, 2009, Super Nova moved pursuant to section 365(d)(3) of the Bankruptcy Code for payment of unpaid rent, attorneys’ fees and prejudgment interest due for the two and a half month period between the date AGC filed its chapter 7 petition and the date AGC was evicted.  The chapter 7 trustee, in turn, moved for summary judgment, arguing that the prepetition issuance of the warrant of eviction terminated the lease prepetition.  Therefore, the lease was not an “unexpired” lease and it did not meet the prerequisite for relief under section 365(d)(3).  The bankruptcy court agreed, granting the trustee’s motion for summary judgment and denying Super Nova’s motion for administrative expenses.  On appeal, the district court affirmed the bankruptcy court’s decision.

Exercising plenary review, the Second Circuit vacated the district court’s decision and held that where a tenant has the power to revive a lease under applicable state law, that lease is “unexpired’ for purposes of section 365(d).  Here, section 749(3) of the New York Real Property Actions & Proceedings Law provides that the “issuing of a warrant for the removal of a tenant cancels the agreement under which the person removed held the premises, and annuls the relation of landlord and tenant, but nothing contained herein shall deprive the court of the power to vacate such warrant for good cause shown prior to the execution hereof.”  N.Y. Real Prop. Acts. Law § 749(3) (McKinney 2011). Interpreting and applying section 749(3), the Second Circuit concluded that although the issuance of a warrant of eviction appeared to cancel any existing lease agreement, AGC retained a residual interest in the lease until the execution of the warrant.  And only when AGC’s residual right to reinstate the lease is extinguished does the lease cease being “unexpired.”

The “unexpired” status of the lease, however, did not mean that Super Nova was automatically entitled to postpetition rent and other costs.  Section 365(d)(3) of the Bankruptcy Code requires that a trustee timely perform its postpetition obligations under an unexpired lease of nonresidential real property only until the lease is assumed or rejected.  Because the issuance of the warrant of eviction explicitly terminated under New York law the lease at issue and because section 365(c)(3) of the Bankruptcy Code prohibits the trustee from assuming unexpired leases that have been terminated under applicable nonbankruptcy law, there was no question that the lease could not have been and was not assumed.  But there remained the question of whether the lease had been rejected.

Specifically, the Second Circuit posed the question of whether or not a “terminated” yet “unexpired” lease should be treated as presumptively rejected, or whether a trustee was required to affirmatively reject the lease.  The Second Circuit noted reasons for and against treating the lease as presumptively rejected, but ultimately remanded the question to the bankruptcy court for a determination.  In remanding the question, the Second Circuit also vacated and remanded the bankruptcy court’s earlier finding that the tenant was not in possession of the commercial property during the approximately two and a half month period before it was evicted, thereby reopening the possibility that the landlord may recover on its unpaid rent, attorneys’ fees and prejudgment interest claims.  The Second Circuit noted marked differences in the material facts presented by AGC and the chapter 7 trustee, on the one hand, and Super Nova, on the other, regarding whether or not AGC or the trustee in fact remained in possession of the property.

Ultimately, the Second Circuit’s holding that a nonresidential real property lease is “unexpired” if a tenant retains a residual right to revive the lease is not novel.  The effect of the holding under New York state property law, however, may mean that retailers and other lessees of non-residential real property could find themselves liable for postpetition rent if they do not reject a lease promptly after filing for bankruptcy, even if the landlord obtained a warrant for eviction before the bankruptcy.