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Landlords Increase Odds In Fighting Abusive Bankruptcy Filings
By Jim Vidmar and Brad Englander
Commercial landlords have new ammunition in fights with bankrupt tenants as a result of two recent court decisions that limit the rights of debtors to use chapter 11 to leverage their position. These two decisions required the dismissal of tenants’ chapter 11 cases because they had not been filed in good faith. In re Integrated Telecom Express, Inc. 304 F.3d 108 (September 20, 2004); In re Liberate Technologies, 314 B.R. 206 (September 8, 2004).
Both debtors filed for chapter 11 in significant part to take advantage of the statutory “cap” on landlord breach-of-lease damages found in Section 502(b)(6) of the Bankruptcy Code. This “cap” on landlord claims figures prominently in chapter 11 cases involving retailers such as K-Mart. The formula for this cap in most cases limits the landlord’s claim for breach of lease damages to one year’s rent. (By contrast, outside bankruptcy, a landlord’s claim for breach damages is typically all rent remaining on the lease.) However, both the Third Circuit Court of Appeals and the California Bankruptcy Court decided that when the principal purpose of the chapter 11 is to “cap” the landlord’s claim, the filing is subject to dismissal.
1. Integrated Telecom
This court held that chapter 11 cannot be used by an otherwise healthy debtor solely to take advantage of the cap on landlord damage claims. Integrated Telecom had plenty of cash at the time of filing and was motivated by the desire to increase distributions to shareholders at the expense of the landlord.
The decision in Integrated was influenced by a “smoking gun”, that is, a board resolution authorizing a chapter 11 filing if major concessions could not be obtained from landlord. It appeared to the court that the bankruptcy filing was being used first and foremost to limit the landlord’s claims in order to increase shareholder distributions.
2. Liberate Technologies
Liberate had cash on hand totaling more than its liabilities and did not need bankruptcy protection to avoid a wasteful liquidation of its assets. Under the debtor’s plan of reorganization, the landlord’s $45 million damage claim was capped at $8 million because of section 502(b)(6). Although the debtor was a defendant in pending litigation, was chronically unprofitable, and had already filed a reorganization plan, the court still dismissed the chapter 11 due to debtor’s lack of good faith.
3. Consequences of Integrated and Liberate
Courts are increasingly scrutinizing chapter 11 filings that target landlords, particularly where the dispute is primarily a “two-party” contest between landlord and tenant. While courts may be somewhat more willing to dismiss cases, this will not be done without a very strong factual demonstration of questionable tenant motives.
Landlords around the country will be examining Integrated and Liberate for the instructions they offer for litigation with tenants. Real estate professionals may rely on these cases in other contexts, particularly where a chapter 11 is filed for a single purpose – that is – solely to reject a contract for sale of real estate or where the thrust of the case is to benefit shareholders ahead of creditors.
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