A Sublessee’s Rights in the Face of A Debtor-Sublessor’s Rejection of an Unexpired Lease Under Chapter 11

(Excerpt) Whether or not rejection of a lease constitutes termination is of great concern to interested parties in a chapter 11 bankruptcy proceeding. This determination can alter the remedies available for injured parties. Section 365 of the Bankruptcy Code establishes the general rule that rejection does not constitute termination, and sets forth the circumstances where exceptions to the general rule apply. In In re Overseas Shipholding Group, Inc., a Delaware Bankruptcy Court held that the rejection of a lease constitutes a prepetition breach of the lease under section 365(g) of the Bankruptcy Code. The court determined the amount of damages a lessee facing rejection of its lease could claim could not be more than what it could claim outside of bankruptcy and that the lessee is subject to underlying agreements and applicable state statutes. The debtor-lessor argued that the case was similar to Chatlos Systems, Inc. v. Kaplan, where a Delaware bankruptcy court found that rejection of a lease constituted termination of the lease. The underlying lease contained a provision that stated that the debtor would not incur any liability to the lessee if the lease were terminated prematurely, therefore, precluding the lessee from bringing a claim for damages against the debtor. However, the Overseas court found the facts in the Chatlos case were dissimilar because in Overseas, the lessee vacated and relinquished possession of the premises, whereas in the Chatlos case the lessee remained in possession. This important distinction changes the lessee’s available remedies in a rejection case. Part I of this article details the background and purpose of section 365. Part II and Part III narrow the discussion to the relevant case law where rejection of a lease does not constitute termination under section 365(g), and the available options and remedies to lessees. Part IV then explores the exceptions in section 365 where rejection of the lease constitutes termination of a lease. This article concludes that a court will look at the actions of the lessee to determine whether rejection of a lease is termination of the lease or a prepetition breach, which in turn, determines the available remedies