Written by: Kimberly Ross Clayson
Schneider Miller PC; Detroit
In a chapter 13 bankruptcy, a debtor in default under a residential lease may assume the lease but the debtor’s plan must provide a cure provision for the pre-petition default. 11 U.S.C. §365. If the debtor later rejects the post confirmation assumed lease, is the lessor entitled to an administrative expense claim for post-petition rents?
In re Eddie Faye Hall, 202 B.R. 929 (W.D. Tenn. 1996), provides an extensive analysis of this issue identifying the code provisions and other case law that supports the notion that a post-petition, post-assumption rent claim may be treated as an administrative expense when the lease is later rejected.
The debtor in Hall filed a case under chapter 13. Pre-petition, the debtor was in default on her residential lease with Millington Housing Authority (MHA). The debtor’s chapter 13 plan listed MHA as a priority creditor and indicated her intention to assume the unexpired rent and to make future rent payments on time and in full. The plan was confirmed. The debtor made her first rent payment under the plan on time and in full. The next month, however, the debtor failed to pay her rent. MHA then filed its motion to have post-petition rent treated as an administrative expense and, at the same time, moved for relief from the automatic stay. The debtor moved out of the premises a few months later. MHA’s motion requested the court to allow MHA an administrative expense claim for two and a half months’ of post-petition rent.
The court cited §§365(a), (b)(1), (g) and 503(b)(1)(A) in beginning its analysis of the issue. Under §365(a) the debtor has the power to assume or reject an unexpired lease. However, under (b)(1) the debtor is required to provide a cure for any pre-petition default and adequate assurance of future performance. In Hall, the court determined that the debtor properly assumed the lease where she disclosed in the plan her intent to assume the lease and where that plan was confirmed by an order of the court. The confirmed plan disclosed debtor’s intent to pay future rent on time and in full. The court found this constituted adequate assurance and provided a cure provision for the pre-petition default in the plan. Thus the debtor had properly assumed the lease, which was later rejected.
Next, under §503(b)(1)(A), allowed administrative expenses must be “actual and necessary costs and expenses of preserving the estate.” The court then returned to §365(g), which states that any post-petition obligation under a rejected lease is generally to be treated as pre-petition claim under the plan. The court concluded that claims arising from the majority of rejected leases were meant to be treated as pre-petition claims. However, the word “generally” in §365(g) allowed room for exceptions that may apply to the treatment of rejection claims as pre-petition claims.
MHA cited two cases to support its motion that it was entitled to an administrative expense claim. Samore v. Boswell (In re Multech Corp.) 47 Bankr. 747 (Bankr. N.D. Iowa 1985) addressed this issue in a chapter 11 with regard to a nonresidential lease. In re Pearson, 90 Bankr. 638 (Bankr. D.N.J. 1988) applied the Multech Corp. holding to a chapter 13 proceeding and a vehicle lease. In Pearson, the debtor assumed a vehicle lease under his chapter 13 plan. Then the debtor turned the vehicle over to the lessor thereby rejecting the lease. The lessor moved for payment of administrative expenses for its claim of damages accruing upon rejection of the previously assumed lease. The basis of the lessor’s motion was that the debtor’s rejection of a previously assumed lease was a post-petition breach, which entitled them to an administrative claim for the deficiency. The Pearson court granted the lessor’s motion.
Pearson relied on §§365(g), 502(g), 503(b) and 1322 in rendering its decision. The court concluded that “post-petition assumption of an unexpired lease was an act of administration and that eventual rejection of that lease by the debtor gives rise to an administrative expense claim for all damages arising from said breach.” In concluding its analysis, the court found that §503(b)(1)(A) along with §1322(a)(7), (power to assume unexpired leases), “worked together to make claims resulting from assumption of a lease actual and necessary costs of preserving the estate.”
The Hall court cited several other bankruptcy principles in deciding whether the post-assumption breach may be treated as an administrative expense. First, a bankruptcy court has broad discretion on whether or not a claim is entitled to administrative priority. Next, “bankruptcy courts should strictly scrutinize claims and narrowly construe the terms ‘actual’ and ‘necessary.’” Finally, the burden of establishing that a claim qualifies as an administrative expense is on the party making the motion. Hall found that this burden required that “the movant show the reasonableness and necessity of the expense and also the benefit conferred upon the estate,” as required by §503. (Internal citations omitted).
After this extensive analysis, the Hall court granted MHA’s motion. The court concluded that the statutes and case law permitted an administrative expense claim for an assumed lease that is later rejected. It was further held that MHA met the §503 standard of showing that its claim was reasonable and necessary. MHA also showed that allowing the debtor to remain in her residential lease post-petition conferred a benefit on the estate because the rent was low. Further, allowing the debtor to assume the lease prevented the debtor from having to seek other housing. As for reasonableness, MHA only claimed two and half months of unpaid post-petition rent where it could have permissibly sought the entire balance of rent according to supporting case law. Finally, it was determined that the necessity requirement was satisfied, considering that the debtor needed housing at all times before, during and after bankruptcy. Finally, the court found that the administrative expense claim was fair where the debtor induced MHA to allow her to remain in her residence when she assumed the lease and agreed to pay the arrearage over time.
The allowance of an administrative expense claim for rejection of a lease that was previously assumed, allows fair treatment of landlords who are stayed from pursuing state court remedies and who may have a significant pre-petition claim for a debtor’s default. It is also fair for debtors; allowing an administrative expense claim gives landlords an incentive to work with bankrupt debtors who wish to remain in their leased residence. When making future financial decisions, debtors must seriously contemplate their desire and ability to remain in the residential lease that they may choose to assume. Allowing an administrative expense claim for rents due after assumption of a lease that is later rejected only enforces the importance of the debtor’s own financial analysis in choosing to assume or reject leases. Sharing these consequences with debtor clients may drastically change their decision to assume or reject their residential lease or any other lease, but it may put the debtor on better financial footing going forward as they are compelled to take a more serious look at how their financial decisions will affect their chapter 13 plan.