• Protecting Claims for Indemnity Obligations When a Commercial Tenant Files Bankruptcy
  • March 11, 2014
  • Law Firm: Kohrman Jackson Krantz PLL - Cleveland Office
  • As a landlord of commercial property, one of the more frustrating situations to endure is a tenant in bankruptcy. While the bankruptcy code provides more protections for commercial landlords than in the residential context, there are still many gray “no man lands” that can trap a landlord.

    One area that can create issues for a landlord is the indemnity obligation a tenant may owe the landlord under a lease. Consider a scenario where tenant signs a lease and proceeds to initiate a very expensive build out of the premises only to file bankruptcy before the construction is completed and the contractor paid. Contractor proceeds to file a mechanics’ lien on the property. The landlord can be forced to spend significant amounts of money in litigation and settlement costs with the contractor to resolve and remove the lien, not to mention the litigation costs in bankruptcy court over the priority of its related indemnification claim against the tenant debtor.

    This was the situation the landlord, WM Inland Adjacent LLC (MW Inland), found itself in after its tenant, Mervyn’s LLC (Mervyn) filed for relief under chapter 11 of the Bankruptcy Code.

    MW Inland requested that its claim was entitled to priority treatment under section 365(d)(3) of the Bankruptcy Code while Mervyn objected claiming it should be treated as a general unsecured claim. Section 365(d)(3) of the Bankruptcy Code provides that the debtor much timely perform all of its obligations under an unexpired lease until that lease is assumed or rejected.

    Critical to the bankruptcy court’s decision in favor of MW Inland was the distinction of an “obligation,” which is “something one is legally required to perform under the terms of the lease” from a “claim,” which is “an unmatured right to payment.” (WM Inland Adjacent LLC v. Mervyn’s LLC (In re Mervyn’s Holdings LLC), No. 08-11586, Adv. Pro. No. 09-50920, 2013 WL 85169 (Bankr. D. Del. Jan. 8, 2013)) The court further found that the obligation arose when the contractor recorded the mechanics’ liens and sued WM Inland to foreclose upon the liens (prior to rejection of the lease), which entitled WM Inland’s claim to treatment as WM Inland had requested under section 365(d)(3).

    The takeaway for a commercial landlord is to consult competent commercial bankruptcy counsel as soon as possible after a tenant files for relief in the bankruptcy court to develop a useful strategy for preserving pre-and post-petition claims it might have related to the tenant’s lease obligations.