Tribune Company Bankruptcy: Preference Avoidance Actions May Be Coming

In late 2010, the Delaware bankruptcy court in the Tribune Company bankruptcy (o8-13141) allowed the Official Committee of Unsecured Creditors to file preference avoidance actions against creditors.  Such lawsuits will allow the Committee to recover payments to creditors within 90 days of the bankruptcy filing, which was December 8, 2008.  If you receive a demand letter from the Committee’s attorney or are sued, please feel free to contact me at bmd@gsrnh.com.

Guaranteeing a Lease: One Size Does Not Fit All

Commercial lessors are wise to have personal guarantees on their leases.  Often times, the tenant is a corporation or other legal entity affording limited liability to its owners.  If the tenant racks up thousands of dollars in unpaid rent, full recovery against the tenant is unlikely.  Thus, lessors will require an officer or owner of the tenant to guarantee the lease’s obligations.  However, using a standard, form guaranty befitting a lender-borrower relationship is not a good idea.  The guaranty for a lease is quite a different creature.

In a lending relationship, lender’s obligations are performed by funding the loan.  The borrowers typical obligation is repaying the loan over time.  There might be other obligations of the borrower, such as providing frequent financial statements to the lender if a line of credit is at issue.  But a lessor-lessee relationship has notable differences.

First, the lessor’s obligation is not fully completed once possession of the premises is delivered to the tenant.  The landlord will usually reserve the right to perform major repair obligations (e.g., structural, roof).  The tenant will have the duty of all other repairs.  This would also include delivering the leasehold to a “vanilla shell” condition when the term expires.  The tenant, of course, similar to the borrower, also pays rent on a periodic basis.

Second, a tenant can free itself of its obligations (albeit contingently) by assigning/sub-leasing to a third-party.  The lessor cannot unreasonably withhold its consent (if the lease has no specific criteria governing assignments) or the tenant must comply with the assignment terms in order to effectuate an assignment.  But what if the landlord does unreasonably withhold its consent?  What effect does this have on the guarantor?

A typical guaranty will provide that no defense to the lease can be used as a defense to the guarantor.  In other words, the guarantor’s performance is just ensuring that the tenant’s obligations are performed.  If a guaranty is not specific enough, it may result in the guarantor being able to use lease defenses against the landlord.

A tenant may interpose as a defense to a breach of contact claim by the landlord that the latter unreasonably withheld its consent to an assignment, thus discharging the tenant from paying any further rent.  The landlord might not care because it has a guarantor.  Unless the guaranty has specific language stating that the guarantor has waived any affirmative defenses or counterclaims based on the lease’s terms, a general waiver may be ineffectual.  There are a line of district court cases in the Northern District of Illinois where guaranties were specific as opposed to general, and thus, the guarantor could not use lease defenses to its advantage.

Thus, when drafting a guaranty for a lease, one should be sure to carefully craft the guaranty to ensure that the guarantor does not have rights under the lease that are co-extensive with the tenant.  This will protect the landlord from affirmative defenses by a guarantor that are based on the terms of the lease.

Leases: Residential Management Company Escapes Fair Debt Collection Practices Act Liability When Collecting Past Due Rent

The Seventh Circuit Court of Appeals recently held in Geanice D. Carter v. AMC, LLC, No. 10-03184 (7th Cir. May 13, 2011), that a management company for an residential apartment owner was not a “debt collector” under the Fair Debt Collection Practices Act (15 U.S.C. Sec. 1692-1692p) (Act).  The Act excludes under its definition of a “debt collector” not only the original creditor, but also any person who tries to collect a debt that “was not in default at the time it was obtained by such person.”  15 U.S.C. Sec. 1692a(6)(F)(iii).  Carter, slip op. at 5.  The Federal Trade Commision’s Division of Credit Practices has opined that a servicing agent of a condominium or of a lessor “obtains” a debt when it becomes the creditor’s agent and is thus not a “debt collector” unless the given debt was in arrears when the agent assumed that role.  Carter, slip op. at 6.     

In Carter, the management company obtained an interest in Carter’s debt to the apartment owner before Carter went in arrears in her rent.  Carter, slip op. at 7.  In other words, it appears that the court of appeals was saying that Carter and the management company entered into the lease.  At some point thereafter, Carter went into default.  The management company was the owner’s agent and this agency arose before the rent delinquency.  As a result, the management company was a not a “debt collector” under section 1692a(6)(F)(iii).

Had the management company assigned the right to collect this debt to another, that exception would not apply because the debt would have arisen first and then the agency relationship would have arisen second.  In other words, the debt would have been in default at the time it was obtained by another from the management company.

This is a great ruling for management companies and the right one under the Act.  When sued as part of an eviction proceeding, tenants may assert a variety of claims or defenses against a management company in order to level the playing field, but liability under the Act is not one of them.   In Illinois, defenses to eviction are limited to those that are germane to possession of the leasehold. 

This ruling has little, if any, impact on commercial management companies since the Act mainly deals with consumer debts.  Some federal appeals courts, however, have applied certain provisions of the Act to the collection of all types of debts.

Commercial Leases: Assignments, Non-Default Clauses and Mitigation (735 ILCS 5/9-213.1)

Many commercial leases allow for assignments/sub-leases by the tenant.  The lease will provide that the landlord (1) will not unreasonably withhold consent to an assingment/sub-lease or (2) specify certain criteria that must be met in order for an assignment/sub-lease to be considered.  Under option (2), some landlords require that a tenant not be in default under the terms of its lease before an assignment/sub-lease will be considered.  For instance, if a tenant is delinquent on rent and wants to get out of the lease and propose an assignment, the landlord will disallow out.  This type of restriction is known as a “non-default” clause.  The goal of the clause is quite clear: a landlord does not want a tenant to skirt its obligations by getting out of the lease leaving unpaid obligations behind.  An assignee will likely not want to pick up such obligations.

A “non-default” clause, on its face, does not appear to violate Illinois public policy.  Private parties are free to contract as they see fit as long as the contract does not violate the Constitution, statutes or common-law (read: judge-made law) of the State.  However, there is one Illinois statute that rears its head in virtually every breach of a lease case: 735 ILCS 5/9-213.1.  This statute provides that a landlord must use reasonable measures to mitigate its damages after a tenant vacates a leasehold.  This means that if a tenant goes out of business and vacates the space, the landlord cannot let the space remain vacant and collect rent from the tenant.  Commercial leases usually provide that even if a tenant abandons the leasehold, that the tenant will still remain liable for the financial obligations (e.g. rent) under the lease.  Section 9-213.1 tempers the relative harshness of this obligation by requiring the landlord to take affirmative steps to find a replacement tenant to take over the space and pay rent.  If the landlord fails to take such steps, it could be barred from collecting rent from the defaulting tenant during the period of time that the landlord failed to take reasonable measures.

But let’s say that the tenant is in default under its lease and abandons the space.  The tenant tenders one or more suitable assignees for the lease.  The landlord refuses to review any of the assignees’ applications citing the non-default clause in the lease.  Is the landlord in the right?  One could argue that the landlord has breached its statutory duty under section 9-213.1 because it failed to review the proposed assignees’ lease applications.  The tenant has proposed suitable replacement tenants which could have feasibly taken over the lease and the space.  The statutory duty to mitigate, which is public policy in Illinois, would trump the landlord’s reliance on the non-default clause.  As applied to these facts, the non-default clause could offend public policy embodied in section 9-213.1.

Landlords should be careful when a tenant abandons a leasehold, but proposes suitable replacement tenants.  Blind reliance on a non-default clause as the basis to refuse to consider reasonable replacement tenants could result in the landlord not being able to recover rent against the vacating tenant after it abandons its leasehold.

Bankruptcy Matters in Illinois – Defending Preference Avoidance Complaints

The Creditors’ Committee in the XMH Corp. 1 (f/k/a Hartmarx Corporation) bankruptcy and the trustee in the Mid-States Express, Inc. bankruptcy have filed preference avoidance actions against the debtors’ creditors. I am currently representing creditors in both cases and have asserted various defenses under section 547(c) of the Bankruptcy Code.

The most common defenses to preference avoidance complaints are found in sections 547(c)(1), (2), and (4) (11 U.S.C. Sec. 547) of the U.S. Bankruptcy Code.