Rejection of Unexpired Lease Equals Pre-Petition Breach of Lease Agreement

Posted by NCBRC - June 1, 2019

Under section 365(g), rejection of an unexpired lease is treated as breach of the lease contract not termination of the lease. Therefore, the lessor’s claim against the debtors for rent based on post-petition, post-rejection occupancy of the leased property was part of the pre-petition breach and was discharged in the debtors’ chapter 7 bankruptcy. In re Roberson, No. 17-8041 (B.A.P. 6th Cir. May 30, 2019) (unpublished).

Joi and Anthony Roberson defaulted on their lease midway through their lease term. When the lessor, GCB Properties III, Ltd., initiated eviction proceedings, they filed for chapter 7 bankruptcy listing the defaulted rent as one of their debts. Neither the trustee nor the Robersons assumed the unexpired lease and the Robersons received their discharge. During the pendency of their bankruptcy case, GCB continued to try to evict them and the Robersons obtained a judgment against GCB for violation of the automatic stay. After discharge, GCB attempted to collect the rent for the months the Robersons lived in the property from the date of the statutory rejection of the lease through the date the Robersons moved out of the property. Furthermore, GCB applied the judgment against it as set-off against unpaid rent. The bankruptcy court found that the rental default up through the time the Robersons vacated the property was discharged in their bankruptcy and therefore the lessor was not entitled to set-off.

GCB appealed to the Bankruptcy Appellate Panel for the Sixth Circuit.

It was undisputed that, by operation of section 365(d)(1), the unexpired lease was automatically rejected 60 days post-petition when neither the Robersons nor the chapter 7 trustee assumed it. The issue was what effect that rejection had on the ongoing unpaid rent as the Robersons continued to occupy the property. Relying on the recent case of Mission Prod. Holdings, Inc. v. Tempnology, LLC, No. 17–1657, 587 U.S. ___, ___ S. Ct. ___, 2019 WL 2166392, at *9 (U.S. May 20, 2019), the BAP found that, under the express language of section 365(g)(1), rejection of the unexpired lease was tantamount to a breach of the rental agreement. Section 502(g)(1) provides that a claim based on a rejected unexpired lease agreement shall be allowed or disallowed “the same as if such claim had arisen before the date of the filing of the petition.” Section 727(b) includes in chapter 7 discharge any claim arising prior to the date of the petition. In Miller v. Chateau Cmtys, Inc. (In re Miller), 282 F.3d 874 (6th Cir. 2002), the Sixth Circuit found that when an expired lease is rejected, debt based on post-petition, post-rejection rent is considered part of the pre-petition breach and is therefore included in the discharge.

The BAP was unpersuaded by GCB’s argument that, once the lease was rejected, any unpaid rent due after that point was no longer a continuation of a pre-petition breach of the lease agreement, but was a new debt based on termination of the lease and the debtors’ status as holdover tenants under Ohio law. The BAP found that because both section 365(g)(1) and the holding in Mission teach that rejection of the lease is not the equivalent of termination but is deemed a breach of the lease agreement, the debtors did not become holdover tenants. While a landlord may take steps in accordance with the lease agreement or with Ohio landlord tenant law to terminate the lease upon breach, GCB did not do so in this case.

In conclusion, the panel offered the following caution: “The Panel cannot overstate the narrow gauge of this opinion, which is premised solely upon the conclusion that rejection of an unexpired lease under § 365(g) creates a breach of the lease, not a termination. Because GCB relied exclusively on its contrary view, the Panel finds no error in the bankruptcy court’s ruling.”

ROBERSON BAP 6th May 2019

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