United States: Bankruptcy Court Holds That Termination Of Lease Does Not Equal Termination Of Estate Property

The Bottom Line

The Bankruptcy Court for the Eastern District of Michigan recently held, in In re Indiana Hotel Equities, LLC, No. 18-45185 (Bankr. E.D. Mich. June 18, 2018) [ECF No. 47], that the early termination of a lease on nonresidential real property neither removed the debtor's interest under the lease from property of the estate nor excepted the property from the automatic stay. The court based its conclusions on language in Bankruptcy Code sections 541(b)(2) and 362(b)(10), respectively, that pertains to the termination of leases, holding that termination "at" or "by" the "expiration of the stated term" of the lease does not include terminations that precede the date specified in the lease as the end of the lease term. While the Bankruptcy Court reached its holding in the context of the debtor-lessee's default under the terms of the lease, it intended its holding to apply broadly in cases involving interpretation of sections 541(b)(2) and 362(b)(10).

What Happened?

Background

Indiana Hotel Equities, LLC (the Debtor) leased real property (together with the lease amendment (see below) (the Lease) from the Indianapolis Airport Authority (the IAA, and together with the Debtor, the Parties) beginning in January 2016, with a term of 72 years dating back to July 1, 1962, when the Parties' predecessors-in-interest were the parties to the Lease. The Lease, of "nonresidential real property" within the meaning of sections 362(b)(10) and 541(b)(2) of the Bankruptcy Code, therefore had a stated term ending on June 30, 2034. Upon the Parties' entry into the Lease, they also entered into a lease amendment, which set forth requirements the Debtor had to meet to avoid default, as well as remedies for the IAA in the event of a default, including cancellation of the Lease.

On May 11, 2017, the IAA notified the Debtor that it had defaulted under the Lease and purported to cancel the Lease pursuant to the lease amendment. The Debtor filed suit against the IAA to challenge its determination of default and subsequent cancellation. At trial, both Parties moved for summary judgment. In Indiana Hotel Equities, LLC v. Indianapolis Airport Authority, Case No. 49D01-PL-027076 (Ind. Super. Ct. Mar. 28, 2018), the Indiana state court granted summary judgment for the IAA, holding among other things that the Debtor had defaulted under the Lease, that the IAA had a resultant right to terminate the lease and validly had done so, and that the Debtor consequently had no right to possession of the property.

The Debtor filed for Chapter 11 bankruptcy on April 10, 2018 (before the date of dispossession), and the IAA filed a "Motion for Relief From the Automatic Stay and for Other Relief" (the Motion), which gave rise to the case discussed herein. In particular, the IAA sought the following from the Bankruptcy Court: (i) confirmation that the Lease, as a result of the IAA's termination thereof, was not part of the Debtor's estate pursuant to section 541(b)(2); (ii) confirmation that the automatic stay did not apply, pursuant to section 362(b)(10), and that the IAA could therefore "exercise its contractual and state law remedies with respect to the Lease and the subject property"; and (iii) waiver of the stay of any order granting the Motion pursuant to Bankruptcy Rule 4001(a)(3).

E.D. Michigan's Opinion

The Bankruptcy Court performed a two-part inquiry into whether sections 362(b)(10) and 541(b)(2) included leases that terminated early regardless of reason, as compared to those that terminated at the end of the term of the lease. First, the Bankruptcy Court considered whether the IAA had validly terminated the Lease. Second, upon finding that the IAA had in fact validly terminated the Lease, it weighed the Parties' respective arguments as to why the termination had or had not occurred "at" or "by" the "expiration of the stated term" of the Lease.

In the first part of its inquiry, the Bankruptcy Court deemed itself bound by collateral estoppel to the state court's findings that the IAA had terminated the Lease prior to the petition date and that the Debtor had no right to possession of the property. The Bankruptcy Court determined that it was required to adhere to the state court's findings unless the Debtor successfully obtained modification or reversal of those findings on appeal.

The Bankruptcy Court then moved to the second part of its inquiry. In relevant part, section 541(b)(2) reads: "Property of the estate does not include . . . any interest of the debtor as a lessee under a lease of nonresidential real property that has terminated at the expiration of the stated term of such lease before the commencement of the case under this title." Similarly, section 362(b)(10) states that: "The filing of a petition under section 301, 302, or 303 of this title . . . does not operate as a stay . . . of any act by a lessor to the debtor under a lease of nonresidential real property that has terminated by the expiration of the stated term of the lease before the commencement of . . . a case under this title to obtain possession of such property . . . ." While the Parties agreed that the respective uses of "at" and "by" in the two provisions did not cause a divergence in meaning, the Parties differed greatly in their interpretations of what constituted the "stated term" of a lease.

On the one hand, the IAA argued that a lease's stated term meant not only the date specified in the lease as its end date, but also an earlier date on which termination occurs pursuant to the terms of the lease or under applicable nonbankruptcy law. On the other hand, the Debtor argued that the stated term of a lease referred only to the lease's specified calendar end date.

The Bankruptcy Court cited several factors in its decision to side with the Debtor and to deny the IAA's motion. First, it noted that the Lease included no language indicating that the Parties had meant to subject the stated term of the Lease — a period of 72 years ending on June 30, 2034 — to the IAA's right to cancel the Lease upon the Debtor's default. Instead, the Parties had set forth this right in terms acknowledging that such cancellation would end the Lease early, before expiration of its stated term. Second, the Bankruptcy Court determined that neither the IAA nor any of the cases it cited had articulated any reason to follow their broad statutory interpretation. Third, the Bankruptcy Court stated that to interpret sections 362(b)(10) and 541(b)(2) as advocated by the IAA would necessitate reading "by/at the expiration of the stated term of the/such lease" out of the statutes. This result would contravene Congress's intent, which was to differentiate these sections from others, like Bankruptcy Code section 365(c)(3) (enacted at the same time as sections 362(b)(10) and 541(b)(2)), in which Congress clearly intended the statute to apply to all lease terminations. Furthermore, to follow the IAA's interpretation would have required the Bankruptcy Court to ignore recent U.S. Supreme Court precedent in which the Court held that, in the bankruptcy context, "a statute ought . . . to be so construed that . . . no clause, sentence, or word shall be superfluous, void or insignificant." Lamar, Archer & Cofrin, LLP v. Appling, 138 S.Ct. 1752, 1761 (2018).

Having denied the IAA's motion, the Bankruptcy Court declined to address whether the IAA's motion was a motion for relief from the stay, since the IAA's focus was whether the stay was applicable. Moreover, the Bankruptcy Court cited concerns that lifting the automatic stay to allow the IAA to remove the Debtor from possession of the property could be detrimental to the reorganization and render superfluous the Debtor's pending appeal of the state court's termination holding. The IAA, the Bankruptcy Court said, could seek other ways of preserving its interest with the automatic stay intact, including seeking adequate protection.

Why This Case Is Interesting

This case adds another member to the ranks of authorities which have interpreted sections 362(b)(10) and 541(b)(2) to apply only to those leases which terminate as a result of the end of the stated term of the lease, and not to leases which terminate for other reasons. With that said, the Bankruptcy Court's decision implies that parties to a lease could include language in the lease that would include within the meaning of "expiration of the stated term" events other than the scheduled conclusion of that term, such as events of default. In Indiana Hotel, the Bankruptcy Court was easily able to differentiate the IAA's cancellation of the lease as an early termination, but other leases may present more complicated cases and may require more fact-specific inquiries into the parties' intentions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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