In re Stable Mews Associates

• Decision Date: 06 December 1983
• Docket Number: Bankruptcy No. 82 B 12454 (HB).
• Citation: 35 BR 603
• Parties: In re STABLE MEWS ASSOCIATES, Debtor.
• Court: U.S. Bankruptcy Court — Southern District of New York

35 B.R. 603 (1983)

In re STABLE MEWS ASSOCIATES, Debtor.

Bankruptcy No. 82 B 12454 (HB).

United States Bankruptcy Court, S.D. New York.

December 6, 1983.

Albert Togut, New York City, Chapter 11 Trustee.

Fischbein, Olivieri, Rozenholc & Badillo, New York City, for three lessees Mr. Moller, Miss Simon and Mr. Gubina; Robert Chira, New York City, of counsel.

Heller, Peck & Levy, New York City, for Mrs. Henry J. Taylor; Edward H. Heller, New York City, of counsel.

William Sutherland, New York City, for Mrs. Henry Cobb.

Edmond C. Granger III, New York City, for Thomas S. Burns.

HOWARD C. BUSCHMAN, III, Bankruptcy Judge.

This case presents the issue of whether tenants of a bankrupt landlord, upon the rejection of their unexpired leases by a trustee or debtor-in-possession, should be subject to reasonable use and occupancy charges.

The debtor, Stable Mews Associates ("Stable Mews") filed for protection under Chapter 11 of the Bankruptcy Code, 11 U.S.C. 1101 et seq., (the "Code") on December 30, 1982. An operating trustee, Albert Togut, was appointed pursuant to § 1104 of the Code on June 1, 1983. Shortly thereafter, the Trustee filed a motion in this Court seeking an order enabling him to reject the unexpired leases and to compel the tenants to pay reasonable use and occupancy charges since the filing of the petition. Various tenants have opposed the motion, claiming, inter alia, that they are liable only for the rent stated in their leases. They do not claim that the Trustee may not reject the leases pursuant to § 365 of the Code. Upon the consent of the parties, the Court has ordered that this matter be treated as a contested matter pursuant to Rule 9014 of the Rules of Bankruptcy Procedure and that the tenants' opposition papers be deemed a motion to dismiss for failure to state a claim pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The facts alleged by the Trustee are, therefore, deemed to be true for purposes of this decision.

In seeking such relief, the Trustee alleges that the debtor owned and operated buildings located at 412-14 East 75th Street in Manhattan. In his brief, the trustee asserts that the cost of maintaining the building and supplying heat and other services to the tenants is excessive and burdensome in light of the rents received. A receiver was appointed for the buildings in furtherance of an order issued on May 14, 1982, by the Supreme Court of the State of New York. After commencement of this proceeding, the debtor entered into a written agreement to sell the buildings for an aggregate sum of $1,750,000, conditioned upon the buildings being completely vacant.

The eight tenants remaining in the building are commercial tenants. Presumably the use clauses in the respective leases restrict use of the premises to commercial use. Three of the eight tenants are holdover tenants; four tenants occupy premises in the buildings pursuant to pre-petition leases expiring during the period from December 31, 1984 through May 31, 1989; the lease of the remaining tenant, Mrs. Henry J. Taylor, expired on August 31, 1983, and she has apparently vacated her leasehold. The leases pertaining to the non-holdover tenants provide for payment of rent ranging from $3.19 to $7.22 per square foot.

In seeking an order levying reasonable use and occupancy charges against the tenants, the Trustee avers that the current market rental rate for such premises has risen to $18 to $22 per square foot. For that reason, he claims that the tenants owe substantial sums in addition to the rent paid since the petition was filed. He further claims that those tenants remaining in possession if the leases are rejected should pay rent on that basis.

The dispute here involves the five non-holdover tenants, the holdover tenants having defaulted or not being able to be served. None is alleged to have failed to pay the rent set forth in his or her lease.

I

Rejection of tenant's leases by a landlord as debtor-in-possession or by a trustee is a rarely litigated issue. 2 Collier on Bankruptcy ¶ 365.09 (15th Ed.1980). But where the rental market has witnessed the inflationary spiral reflected by the Trustee's claim for reasonable use and occupancy charges here, a trustee's general duty to maximize the return to creditors leads to the claim that tenants remaining in possession should pay current market rents rather than the rent set forth in their leases. Similarly, it may be in the best interests of the estate for a building belonging to a debtor to be vacated and sold or for the trustee to be freed of the debtor's obligations imposed by the tenant's leases.

Whether tenants may be forced to quit the premises and whether the trustee may reject burdensome lease covenants were resolved by § 70(b) of the former Bankruptcy Act, 11 U.S.C. § 110(b) (repealed). Congress there recognized the interests of the creditors and the debtor by empowering the trustee of a lessor with power to reject an "unexpired lease or any covenant therein." In so doing, however, Congress balanced that power and recognized the competing interests of the tenants. It rejected the notion that the estate should be benefitted by removal of the tenant, providing that such rejection "does not deprive the lessee of his estate." In § 365(h) of the Code, Congress reaffirmed at least the possessory attributes of a lease, see Matter of Barnett, 12 F.2d 73 (2d Cir.1926), cert. denied sub nom. United Cigar Stores v. Rayher, 273 U.S. 699, 47 S.Ct. 94, 71 L.Ed. 846 (1926), and recognized the tenant's right to offset from his rent the damages caused by rejection, such as the failure to perform lease covenants.

Whether Congress, in § 70(b) of the Act, went further and intended to permit the trustee to increase the rents if the tenant remained in possession is not at all clear from a review of the extant authorities. For example, different editions of the same treatise state exactly contrary positions. In 2 Collier on Bankruptcy ¶ 365.09 (15th ed. 1980), the author refers to a pre-Code "general assessment that there was no power in a bankruptcy court to deprive a tenant of his estate directly or indirectly by increasing the rent," citing to Creedon and Zimmer, Landlord's Bankruptcy: Laissez Les Lessees, 26 Bus.Law. 1398 (1971) ("Creedon and Zimmer"). In so opining, the author claimed that In re Freeman, 49 F.Supp. 163 (S.D.Ga.1943), stating the contrary, was wrongly decided. In 4A Collier on Bankruptcy ¶ 70.44, p. 541, n. 6 (1978) it is written, however, in referring to the non-deprivation of estate proviso of § 70(b), that:

The meaning of this provision was set forth as follows in Matter of Freeman supra, citation omitted . . . the relation of landlord and tenant is not disturbed, but the contract of rental no longer binds either of them, and the trustee may charge and recover a reasonable rental for the demised premises until the end of the term.

There exists varying support for each of these diametrically opposed views. Freeman has been justly criticized for its ultimate holding that a tenant whose lease has been rejected continues in its leasehold estate only at sufferance as a holdover tenant subject to eviction. See 2 Collier on Bankruptcy § 365.09 (15th ed. 1980). That result is contrary to the possessory nature of an estate for a term of years, i.e., a leasehold, and thus a misinterpretation of § 70(b).

But the Freeman court's distinction between the relationship of landlord and tenant, i.e., privity of estate, and the necessary contractual relationship also embodied in a lease, has its root in Judge Swan's opinion in In re Wil-Low Cafeterias, 111 F.2d 83 (2d Cir.1940) where he noted that adoption of a lease by a bankrupt tenant "creates privity of estate but no privity of contract," thereby absolving the debtor from liability for subsequent rent upon the assignment of the lease. To the Freeman court, and as argued by the Trustee here, the lack of privity of contract enables the trustee to charge market rent.

This line of reasoning subsequently was adopted by the Seventh Circuit in In re Schnabel, 612 F.2d 315 (7th Cir.1980). There, a real estate developer had leased a restaurant. The tenants failed to pay rent for nine months that they remained in possession after the developer filed and was adjudicated a bankrupt. In holding the tenants liable for fair rental value for use and occupancy of the premises since the filing of the petition, the Court ruled that the trustee had rejected the lease by not assuming it within 60 days as provided in former Rule 607 of the Rules of Bankruptcy Procedure and followed the reasoning expressed in 4A Collier on Bankruptcy ¶ 70.44 at 541 n. 6, observing:

We find Collier\'s view very logical and we adopt it here. Regardless of whether the trustee assumes or rejects the lease, he has title to the underlying premises . . . Rejection merely frees the estate and underlying premises from the lease obligation so that the trustee may operate the premises as profitably as possible for benefit of the estate.

612 F.2d at 317. The court carried this reasoning further than required, however, in stating, in dicta, that the trustee could sell the premises free of the lease, ignoring the possessory characteristics of an estate for a term of years.

Support for the contrary position that the rent due a trustee or debtor as landlord continued unmodified lay, as noted by Creedon and Zimmer, supra, p. 1409, in the seeming acceptance of that proposition by cases in this circuit holding that a tenant's renewal rights are part of the tenant's estate under § 70(b) of the Act and therefore are enforceable after rejection of the lease. In In re New York Investors Mutual Group, Inc., 153 F.Supp. 772 (S.D.N.Y.1957), aff'd sub nom Cohen v. East Netherland Holding Co., 258 F.2d 14 (2d Cir.1958), the lease contained a clause affording the landlord with the choice of granting a 21 year renewal of the lease or paying the lessee the value of...