During the past few years, some tenants have found themselves leasing more office space than they needed at rental rates higher than the market rate, which has continued to slide in most markets. Some companies in this situation have used the threat of filing for bankruptcy-court protection in an attempt to get out of their lease obligations. Under the bankruptcy code, a landlord's claim is capped at the greater of one year of rent or 15 percent of the remaining rent, not to exceed three years.
A handful of recent cases have ended in judgments allowing a solvent tenant to file for bankruptcy-court projection and breach its lease agreement, limiting the amount landlords could collect, say attorneys. But an appellate-court decision issued last week and a bankruptcy-court decision issued two weeks ago may actually prompt tenants to think twice about using or pursuing such threats — at least for now.
Last week, a three-judge panel of the U.S. Court of Appeals for the Third Circuit in Philadelphia ruled that both the U.S. District Court for the District of Delaware and the U.S. Bankruptcy Court for the District of Delaware "erred" in concluding that Integrated Telecom Express Inc. "suffered financial distress" that justified the company's Chapter 11 petition. Under bankruptcy protection, Integrated Telecom would be required to pay just $4.3 million of the $26 million the company owed to its landlord under the lease agreement.
Integrated Telecom, a supplier of broadband equipment and software, struck a 10-year lease deal with the owner of an office building in San Jose, Calif., agreeing to pay $200,000 a month in rent for the space beginning in 2001. The landlord challenged Integrated Telecom's Chapter 11 filing on grounds that it was not filed in "good faith," first in district court in April 2003 and in the court of appeals in May. The landlord contended that the company, which moved to Cupertino, Calif., late last year, has plenty of cash and that the Chapter 11 petition was filed simply to reduce the amount owed to the landlord.
The appeals court did not allow Integrated Telecom's Chapter 11 petition to stand. Experts say that if the court had allow it to stand, any tenant unhappy with the terms of a lease would have been able to file for bankruptcy and get out of the lease regardless if it's in financial distress. This ruling prevents these type of bankruptcy cases.
Two weeks ago in a similar case, a judge for the U.S. Bankruptcy Court for the Northern District of California in San Francisco dismissed Liberate Technology Inc.'s Chapter 11 petition, ruling that the San Mateo, Calif., television software maker can solve its problems without bankruptcy protection.
Judge Thomas E. Carlson wrote that while the company's business "is unsuccessful," the company nonetheless "has cash well in excess of its liabilities and does not need bankruptcy protection." In his ruling, Judge Carlson notes that Liberate holds $212 million in cash and at most, its liabilities total $167 million, including $45 million in rent remaining under a lease agreement with the company's landlord.
To reduce costs prior to filing its bankruptcy petition in April, Liberate vacated its nearly 181,000-square-foot headquarters, where it was paying $683,823 a month, and leased 15,011 square feet of space in another building for $26,269 a month, according to court documents.
Circle Star Center Associates L.P., the landlord of Liberate's former headquarters and Liberate's largest creditor, filed a motion with the court in June to dismiss Liberate's Chapter 11 bankruptcy case. Under bankruptcy protection, Liberate would owe its landlord only $8 million, rather than the $45 million in rent remaining under the lease agreement, according to court documents. Liberate has filed an appeal with the U.S. District Court in San Francisco, according to Desmond Cussen, a San Francisco attorney at Gibson, Dunn & Crutcher LLP, who is representing Liberate.
While attorneys say it's too soon to tell how much of an impact these two rulings will have on landlord-tenant negotiations, many believe it will prompt landlords to take a tougher line toward tenants trying to terminate a lease.
