Bankruptcy Court Rules Debtor-Assessor Not Safe for Pre- and Post-Assignment Damages Under Lease Assigned Before Bankruptcy Because Landlord Never Granted Release | Pillsbury Winthrop Shaw Pittman LLP
Before filing Chapter 11 as part of the RGN Group case, H-Work LLC (H-Work) was a tenant under a seventh amended commercial lease with the owner Teachers Insurance and Annuity Association (TIAA). The lease permitted assignment to entities under common ownership or control of H-Work, and prior to the bankruptcy filing, H-Work assigned the lease to RGN-Dallas, a special purpose entity with no assets and commonly controlled who did not seek legal redress. As part of the assignment, RGN-Dallas assumed the obligations and liabilities of the lease, but H-Work never obtained a release from TIAA.
After the surrender, RGN-Dallas and TIAA entered into two lease amendments â the Eighth and Ninth Amendments. The Eighth Amendment extended the term of the lease by one year to allow the parties to negotiate the Ninth Amendment. The Ninth Amendment provided for larger office space in a different building, higher rent, and a 13-year lease term. He also demanded that TIAA move tenants out of the space so RGN-Dallas could move in. H-Work has not implemented the Eighth and Ninth Amendments.
Although TIAA later made the space available, RGN-Dallas never budged. After the Eighth Amendment expired and RGN-Dallas failed to pay rent on time, TIAA terminated RGN-Dallas’ tenancy. In the meantime, H-Work has filed for Chapter 11 relief.
TIAA filed a proof of claim against H-Work in the amount of $5.7 million, reflecting its calculation of the cap on claims for damages to owners under section 502(b)(6) of the bankruptcies. Except for unpaid rent arising from the Eighth Amendment, all other alleged damages arose under the Ninth Amendment, to which Debtor H-Work was not a party. If allowed, TIAA’s claim would be paid in full as part of H-Work’s confirmed Chapter 11 reorganization plan.
Contractual confidentiality remains between the debtor H-Work and TIAA
H-Work opposed the claim. He argued, among other things, that during the execution of the Eighth Amendment by RGN-Dallas and TIAA only, he lost contact with TIAA and could not be held responsible for the Eighth or Ninth Amendments to which he was not a party. . In response, TIAA argued that H-Work’s lease obligations survived assignment under Texas law because H-Work was never released by TIAA.
The bankruptcy court ruled in favor of TIAA. According to the court, under Texas law, an assignment does not release a tenant-assignor’s continuing lease obligations, and confidentiality is not breached, unless the landlord affirms it.
Material Change Doctrine
H-Work also argued that the bankruptcy court should apply the material change doctrine to infer or impose a discharge from post-assignment obligations. The doctrine “aims to prevent injustice from being inflicted on a transferor when a transferee signs new and different terms to which the transferor never consented”. According to H-Work, the Ninth Amendment significantly changed the terms of the lease by providing for a new building, higher rent, larger offices, and a 13-year lease term â terms that H-Work claimed it did not have. negotiated, but instead were negotiated by RGN-Dallas and TIAA.
The court rejected the argument. Texas, unlike some other states, does not recognize the material change doctrine. And even if it did, the court noted that there was no sense in applying it when the debtor-assignor’s lease obligations were assigned to a “non-asset special purpose entity created to hold the [l]facility”, where “the same person was and continues to be the authorized person for both RGN-Dallas [assignee] and [Debtor-assignor].â The court further observed that â[f]In TIAA’s view, the assignment was likely to have no material economic or legal consequences, since it continued to deal with the same legal entity that had always been its tenant.
Therefore, the court ruled that H-Work would be liable if RGN-Dallas violated the Ninth Amendment.
RGN-Dallas violated the Ninth Amendment
Finally, H-Work argued that RGN-Dallas never violated the Ninth Amendment because RGN-Dallas did not occupy the new space and the move never happened.
The bankruptcy court disagreed, finding that the Ninth Amendment was enforceable and binding on the date of execution, so TIAA could recover damages for breach notwithstanding RGN-Dallas’ failure to take possession of space. Since the TIAA was required to anticipate the costs of preparing the new space and relocating tenants to the other building and RGN-Dallas had not paid the rent, the court ruled that the Ninth Amendment had been breached and, subject to certain adjustments, he allowed proof of TIAA’s claim for a reduced amount of approximately $3.4 million.
Planning and exploration options
This decision demonstrates that landlords should not quickly conclude that a former assigning tenant is relieved of liability for post-assignment breaches of the lease, even if the assignment was authorized under the lease. It would have been easy and understandable for the landlord to move away from the previous tenant, especially since the selling tenant has filed for bankruptcy. In this case, however, the transferring tenant’s Chapter 11 plan provided for full payment of such unsecured claims, and as such, it appears that the landlord’s thoroughness and persistence will pay off.
Conversely, this case teaches an important lesson to the allocation of tenants. Those who believe that a release from future lease obligations after assignment is the benefit of the deal would be wise to obtain a formal release from the landlord. Otherwise, they risk future obligations under the lease as assigned and the potentially amended lease.