Recent Bankruptcy Developments Impacting The Landlord-Tenant Relationship

In drafting the provisions of the Bankruptcy Code relating to nonresidential real property, Congress intended commercial landlords to be "entitled to significant safeguards."1 Examples of the protections afforded to commercial landlords include requiring a debtor to remain current in its payment of post-petition rent;2 allowing landlords to drawdown on a letter of credit without prior bankruptcy court approval;3 permitting landlords to and/or lease rejection damages;4 setoff pre-petition unpaid rent against a security deposit recognizing that a tenant's possessory rights in nonresidential real property have been extinguished, and the lease cannot be assumed, where the lease is terminated in accordance with its terms and applicable law;5 and limiting the time within which a debtor may extend the time it has to assume or reject the commercial lease in the absence of landlord consent.6

Notwithstanding these protections, the landlord–tenant relationship can be a complicated one, and landlords with a tenant in bankruptcy often end up feeling held hostage. Recent decisions in bankruptcy courts in the District of Delaware and the Central District of California shed new light on the contours of this relationship and offer additional guidance to both landlords and tenants attempting to navigate the process.

Indemnification

Commercial leases commonly contain indemnification language, pursuant to which a tenant is obligated to indemnify the landlord for liability incurred during the lease term. When a tenant files for bankruptcy protection, what happens to that indemnification right? Though the answer may ultimately depend on the timing of events and the jurisdiction, Judge Gross in the United States Bankruptcy Court for the District of Delaware recently held that a claim arising from an indemnification provision in a nonresidential real property lease rejected post-petition was entitled to administrative priority pursuant to section 365(d)(3) of the Bankruptcy Code.7

In January 2008, Mervyn's LLC (Mervyn's), a department store chain, entered into a lease for commercial property in San Bernadino, California, owned by WM Inland Adjacent LLC (WM Inland). Before it moved in, Mervyn's arranged for improvements to be made to the premises and on January 28, 2008, Mervyn's entered into a construction agreement with Fischer Development Inc. (Fischer) for work to be done at a cost of over $6 million. Both the lease and the construction agreement contract with Fischer...