Federal Court Awards Fifth Avenue Landlord Multi-Million Dollar Judgment for Rent Arrears Release in Tenant’s Chapter 11 Bankruptcy

BY JAY B. SOLOMON & ISRAEL A. KATZ
While the Covid-19 pandemic is (hopefully) now behind us, commercial landlords still find themselves enmeshed in litigation to recover significant rent arrears owed under commercial leases signed before the onset of the pandemic.
In a recent hotly contested Federal Court case in which BBG represented a Fifth Avenue commercial landlord (“Landlord”), the U. S. District Court for the Southern District of New York entered a judgment totaling more than $2.8 million (representing all rent owed plus attorneys’ fees incurred) against the parent company (“Guarantor”) of the Spanish-based retail designer Desigual, that had guaranteed tenant Desigual’s lease obligations. Notably, in what is currently a hot-button bankruptcy issue (with legislation pending in both houses of Congress), the Court rejected Guarantor's arguments that Landlord had released it from liability pursuant to a non-debtor third party release provision included in Desigual’s previously-approved Chapter 11 bankruptcy plan.

In January 2020, Desigual entered into a three-year lease, but by mid-May 2020, it ceased renovations and refused to pay rent. After Landlord issued default notices, Desigual filed for bankruptcy in July 2020, immediately commenced an adversary proceeding against Landlord in Bankruptcy Court, and filed an emergency motion to enjoin Landlord from drawing down on its letter of credit that had been deposited with Landlord as security under the lease.
Desigual alleged that the lease was void or voidable under the doctrines of impossibility of performance, frustration of purpose, force majeure and lack of consideration. 
The Bankruptcy Court rejected Tenant’s defenses and upheld the validity of the lease, resulting in a final judgment in favor of Landlord which was affirmed on appeal. Other than defending its rights in the adversary proceeding, Landlord’s participation in Desigual’s bankruptcy case was limited to objecting to Desigual’s attempt to “reject” the lease Guaranty
along with the lease, and filing a proof of claim based upon Landlord’s lease rejection damages claim. Landlord did not participate in the bankruptcy plan filing or approval proceedings, and critically, was not ever provided with the bankruptcy plan solicitation package or ballot to vote to approve or reject the plan.
In February 2021, Landlord commenced suit in Federal Court against Guarantor under its guaranty for the amount of unpaid rent owed under the lease. The Court rejected Guarantor's release defense because the
release in Desigual’s Chapter 11 bankruptcy plan only released claims that were derivative or vicarious of Desigual’s liability, whereas Guarantor's liability under the lease guaranty was primary and distinct and would continue regardless of whether Desigual had a defense to liability under the lease. The Court further narrowly construed the plan’s release provision, holding that nonconsensual third party releases are only enforced in rare cases, and Guarantor failed to explain “why the Plan should be read to extinguish all of its obligations to anyone who happened to do business with its American subsidiary—the organization that actually declared bankruptcy.”
The Court further dismissed Guarantor's frustration of purpose and impossibility defenses because “neither temporary lockdown orders nor economic hardship excuse obligations under a commercial lease, and Guarantor's expert report provide[d] no information suggesting any other factual basis for its defenses.” The Court further held that a necessary element of both frustration of purpose and impossibility of performance
is that the claimed circumstances giving rise to the frustration are objectively unforeseeable and could not have been guarded against in the contract. Because the possibility of store closures and business interruptions were expressly contemplated by the parties in the lease, the Court rejected those defenses.
In what will likely be cases of first impression at the Circuit Court level, both Desigual and Guarantor have appealed the respective District Court rulings to the Second Circuit Court of Appeals. BBG represents Landlord in both appeals.  The attorneys at BBG can assist and counsel owners with the recovery of unpaid rent arrears from commercial tenants and guarantors, including those that have filed for bankruptcy protection. Owners finding themselves in such a situation are encouraged to contact us to discuss their rights and remedies.

Jay B. Solomon is a partner, and Israel A. Katz is an associate, in the Firm’s Litigation Department, concentrating in complex commercial litigation matters. Jay can be reached at 212-867-4466 ext.497 (jsolomon@bbgllp.com), and Israel can be reached at 212-867-4466 ext.824 (ikatz@bbgllp.com). 
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