Landlord’s Rent at Risk in Bankruptcy

November 7, 2011
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Is a landlord’s rent at risk of being “clawed back” in a tenant’s bankruptcy? Unfortunately it is, but not to despair. A defense exists – the right to deduct subsequently accruing but unpaid rentals from the amount being “clawed back.” To see this in operation, consider the following.

In its heyday, a retailer — we’ll call them Tony’s Tee Shirts — leased stores all over a major metropolitan area. Winding downwards to its bankruptcy filing, Tony’s began using the stores for liquidation sales. It then decamped, often leaving the last months of rent unpaid. To add insult to injury, Tony’s bankruptcy trustee later filed a number of law suits against – among others – its former landlords. These were “preferential transfer” suits, based on the Bankruptcy Code section which lets a bankrupt “claw back” payments made to creditors within the last ninety days before bankruptcy. In Tony’s case, the trustee sought all rent paid within that ninety days.

We represented one of the landlords – a very unhappy landlord. However, we were able to come up with a complete defense to the complaint – using the so-called “new value after” defense allowed under the Bankruptcy Code. Here’s how it worked in our client’s case.

In mid-July of the year it filed bankruptcy, Tony’s paid our client $37,000 in rent for May and June. Tony’s then filed bankruptcy in September, thus placing the $37,000 squarely within the ninety day period. Tony’s remained on our premises until October 30th, conducting a “going-out-of-business” sale, thus benefitting from the use of the leased premises. It never paid the rent for July, August, and September.

The Bankruptcy Code provides several defenses to preferential transfers. One is “new value after.” This holds that a preferential transfer must be reduced to the extent that, after the transfer, the defendant provided “new value” to the debtor. We therefore asserted that the unpaid rental value of our client’s premises, accruing after the preferential transfers, was such “new value” and needed to be deducted. [In fact, it completely zeroed out the alleged preferences.]

The lead case for our position is Southern Tech. College v. Hood, 89 F.3d 1381, 1385 (8th Cir. Ark. 1996), where the court stated that “[debtor] may not avoid the preferential transfer to the extent that the new value — nearly two rent-free months — remains unpaid for and unsecured.” And see Ross v. Philadelphia Hous. Auth. (In re Ross), 1997 Bankr. LEXIS 2352, *15 (Bankr. E.D. Pa. June 10, 1997)(“[T]he continued use and occupancy of the dwelling unit . . . is thus new value to be set off against the debtor’s recovery of the preference.”).

The trustee’s response was to agree to dismissal. Case closed. One happy landlord.