U.S. Bankruptcy Court
Where a Chapter 11 debtor in possession has rejected a commercial lease, payment of rent into escrow is appropriate, as it would be inequitable for the tenant to withhold post-rejection rent as ‘recoupment’ for pre-rejection damages that have been claimed but not proven.
“The parties disagree as to whether MIM may recoup its alleged prepetition, pre-rejection damages against post-rejection rent that becomes due under the Lease. …
“It is undisputed that if a debtor that is a lessor rejects a lease, a tenant may elect to retain certain rights under the rejected lease. …
“Under §365(h), MIM is entitled to remain in possession of the Leased Premises for the balance of the of the Lease term, and any renewal or extension period. 11 U.S.C. §365(h)(i)(A)(ii). …
“As such, post-rejection, the Debtor does not have the obligation to maintain the Leased Premises by keeping the roof in ‘good order and repair’ as would otherwise be required by section 12 of the Lease and applicable nonbankruptcy law. MIM may undertake to do that at its expense and may offset the cost against future rent, but it has not done so. MIM may not offset alleged post-rejection consequential damages that arise from a failure to maintain the roof where the Debtor no longer has a contractual obligation to maintain the roof and MIM has elected to remain in possession of the Leased Premises.
“The more difficult question is whether MIM may offset or recoup alleged prepetition, pre-rejection damages from post-rejection rent reserved under the Lease. …
“Even where equitable recoupment may be a remedy available to MIM (assuming the Lease was not terminated by notice), MIM has yet to meet its burden of proof on a number of issues and, therefore, equitable recoupment only remains a potential remedy as to which the Court has latitude in applying to fashion equitable relief. … In the context of this case, it would be inequitable for MIM to withhold post-rejection rent as ‘recoupment’ for pre-rejection damages that have been claimed, but not proven and, therefore, payment of rent into escrow is appropriate. …
“For the reasons above, I grant the Motions in part as follows. MIM may have the right to equitably recoup against post-rejection rent reserved under the Lease, but may only do so once that right is established upon determination of the Claim Objection that has been consolidated with the Adversary Proceeding. In the interim, MIM is obligated to pay rent as required by the Lease. This means that MIM shall pay into an escrow account with its counsel rent going forward as required by the Lease and shall propose a schedule to pay rent that was due post-rejection, commencing April 1, 2024. The Receiver shall file a proposed schedule of post-rejection ‘catch-up’ rent payments within ten (10) days of the date of this Order.
“I will schedule a case management conference to discuss litigation of the Claim Objection and Adversary Proceeding. If MIM prevails with respect to its claims, I will rule on its right to equitably recoup the allowed claim amount against rent reserved under the Lease either in the context of plan confirmation or in a further order. …”
In Re: Mohawk Drive Corp. (Lawyers Weekly No. 04-017-24) (16 pages) (Panos, J.) (Chapter 11 Case No. 24-40250-CJP) (Dec. 6, 2024).
Click here to read the full text of the opinion.