Bankruptcy and Leases

12 Feb Bankruptcy and Leases

The prevalence of leases continues to grow.  Many individuals want to drive a newer car but could not otherwise afford the car outright.  Many businesses want commercial space but cannot afford the cost of purchasing a commercial building and its upkeep.  Most leases go off without any problems.  However, when problems do occur the parties have to look to the lease (contract listing rights and responsibilities) to determine what remedies are available.  In most cases the leases have been drafted by the lessor (landowner or car financing company) and the terms of the lease typically favor the lessor.   Penalties are often included for breach of a lease.

Bankruptcy law allows assumption or rejection of an unexpired lease.  11. U.S.C. sec. 365 Assumption or rejection is the power to say, “I don’t like the terms or the lease and I want out of this lease.” or “I want to continue under the terms of the lease.”  If the latter is chosen the lease carries on under the terms.  If the former is chosen the lessee is granted release from the lease.

If the lease is not assumed and is rejected, the next step is the determination of damages.  In the case chapter 7 bankruptcy the lease damages will be included in schedule F or unsecured debt.  11 U.S.C. sec. 727(b)  In the case of chapter 7 the only way a lessor is paid is if the estate has funds after the exemptions are applied.  Most chapter 7 cases are referred to as a “no asset” bankruptcy and no creditors are paid, including rejected leases.  Chapter 7 can be a very good vessel for getting rid of a lease that is too expensive.

In the case of chapter 13 bankruptcy again, the lease may bee assumed or rejected.  If the lease is assumed it is paid as an expense according to the terms of the lease.  In the case where a lease is rejected again the issue becomes on of damages.  In a chapter 13 case or “wage earners plan” some money goes back to creditors.  In many cases the amount claimed as damages for a broken lease does not matter because the plan only pays a portion of the total debt over the 3 or 5 year period.  An inflated damage claim in the case of a less than 100 percent plan only reduces the amount paid to other creditors.  Damage claims in cases of a 100 percent plan matter because a debtor is expected to pay all of the debt owed in the 3 or 5 years.

In many cases lessor’s attempt to add in as many damages as possible to ensure they are made as whole as possible.    In the case of commercial leases assumption or rejection is made according to 11 U.S.C. §365.  In the case of a commercial lease a damages can be greater given the duty to continue to fulfil duties until the lease is rejected.  If the obligation for the post petition lease expenses are unpaid, a claim can be made for administrative expense.   Many courts allow that these administrative expenses to have a “super priority” meaning they are paid before anything else.