Scott E. Mollen

Landlord-Tenant—Bankruptcy—Private Landlord Is Not a Governmental Unit Subject to Bankruptcy Code §525's Anti-Discrimination Provision Barring Governmental Units from Evicting Debtors Based on NonPayment of Prepetition Discharged Rent

This decision addressed the "important issue whether Bankruptcy Code Section 525's antidiscrimination provision, prohibiting a governmental unit from evicting a debtor on the basis of nonpayment of prepetition discharged rent, applies to a private landlord participating in the Section 8 Housing Choice Voucher Program" (§8 Program). All references to "sections" refer to the Bankruptcy Code.

The landlord sought to evict a tenant debtor from her §8 subsidized apartment in state court (State Court Eviction Proceeding) based on the debtor's failure to pay both prepetition discharged rent and post-petition rent. If §525 is inapplicable to the landlord, §365(d)(1) required the debtor to "cure all prepetition rent arrears in order to assume her residential lease, or the lease is 'deemed rejected.'" 11 U.S.C. §365(d)(1). Section 525(a) prevents a "'governmental unit' from revoking or refusing to renew a lease because a debtor has not paid discharged debt."

The debtor had moved to "reopen her Chapter 7 case and stay the State Court Eviction Proceeding" because the landlord violated the Bankruptcy Court's "discharge injunction by seeking to evict the debtor based on prepetition discharged rent arrears." The debtor also contended that any further efforts by the "landlord to evict her based on discharged rent would be discriminatory under (§525), which protects a debtor from discriminatory treatment by a governmental unit."

The landlord's present counsel would not agree to limit the State Court Eviction Proceeding to "solely post-petition rent arrears." Therefore, the Bankruptcy Court (court) reopened the debtor's Chapter 7 case and stayed the State Court Eviction Proceeding. The court noted that the subject issue was an "important issue of bankruptcy law on which there was a split in lower court decisions."

The court concluded that §525(a)'s "non-discrimination provision does not apply to the landlord." Thus, the debtor's "lease was terminated as a matter of law because it was 'deemed rejected' due to the debtor's failure to timely cure the prepetition arrears." 11 U.S.C. §365(d)(1). The court lifted its prior stay and permitted the landlord to proceed with the State Court Eviction Proceeding against the debtor based on prepetition and post-petition arrears. However, the court stayed its decision to provide time for an appeal. The court further stated that the prepetition arrears had been discharged as "a personal liability of the debtor" and the landlord "may not take any action now to recover the discharged debt."

The landlord is a private residential property owner that had entered into an agreement with the US Dept. of Housing and Urban Development (HUD), permitting the landlord to "administer the Property as low-income housing in exchange for Section 8 Program subsidies." When the debtor commenced her Chapter 7 bankruptcy case, she was a defendant in an eviction proceeding filed by the landlord based on outstanding rent. The landlord was listed as a creditor on the debtor's schedule when the Bankruptcy Court entered an order discharging the debtor and closing the debtor's bankruptcy case. The tenant's prepetition rent obligations to the landlord were discharged. The Chapter 7 case was closed in April 2018. In May 2018, the landlord's prior eviction proceeding was discontinued.

However, in July 2018, the landlord sent the debtor a demand for payment, seeking payment of the prepetition discharged rent, in addition to the post-petition rent. The combined rent due was $39,922.

In September 2019, the landlord commenced a new nonpayment proceeding i.e., the State Court Eviction Proceeding, seeking to evict the debtor based on both prepetition discharged rent arrears and post-petition rent arrears. At that time, the tenant allegedly owed $42,622 ($19,735 in prepetition, discharged rent and $22,887 in post-petition rent).

In November 2019, the debtor moved for an order reopening the Chapter 7 bankruptcy case and imposing the Bankruptcy Code's automatic stay (§§524(a)(2) and 105), to stay the State Court Eviction Proceeding.

The debtor's counsel acknowledged that the State Court Eviction Proceeding could proceed based solely on the post-petition unpaid rent of $22,887. However, the landlord did not agree to limit the State Court Eviction Proceeding solely to unpaid post-petition rent. Based on the landlord's position, the court granted the debtor's motion to reopen the Chapter 7 bankruptcy case and stayed the landlord from proceeding with the State Court Eviction Proceeding or any other action against the debtor.

The court explained how the §8 Program operated. The debtor had argued that the landlord is a "governmental unit" within the meaning of §525(a) and therefore cannot evict the debtor for nonpayment of discharged rent. In arguing that the landlord is a "governmental unit", the debtor argued that (a) the debtor's tenancy and the landlord's "ownership of the building" is wholly subject to HUD's subsidies, rules, and regulations; (b) HUD had "pervasive influence and involvement in the management" of the landlord; (c) §8 was created "by federal statute"; (d) the landlord participates in the §8 Program and receives HUD subsidies in exchange for "managing the building in accordance with HUD's rules and regulations"; (e) the §8 Program is governed by the HUD Handbook, "which covers nearly every aspect of building management"; (f) HUD's "HAP" contracts with landlords establish "several conditions for accepting HUD's subsidies" and if landlords fail to cure defaults under the HAP contracts, HUD may take remedial actions against the landlords; (g) HUD has special requirements for tenant eligibility in §8 housing, but "places enforcement of those requirements on its 'project-based owners'" and the owner must "recertify the tenant's eligibility to HUD annually"; and (h) the landlord's website states that the management company is partially funded by HUD. In summary, the debtor contended that there is "substantial entwinement between HUD" and the landlord.

The court explained that if the landlord is a governmental unit, the debtor's motion "highlights a conflict between section 525's non-discrimination provision regarding residential leases with governmental units and section 365, which permits a landlord to evict a tenant from a rejected lease for nonpayment of discharged prepetition rent."

The debtor asserted that a Second Circuit case held that "when sections 365(b) and 525(a) come 'foot to foot' in the public housing context, section 365(b) must step aside to let section 525(a) pass."

The landlord argued that it is not a governmental unit. Rather, it is a "limited partnership formed under New York law" for the "purpose of owning and renting apartment buildings." The landlord emphasized that private landlords "participating in a federal subsidy program are not included in the Bankruptcy Code's definition of 'a governmental unit.'"

The court stated that the debtor had not established that "HUD or any other government agency completely oversees the building's operation and administration." Although the landlord receives funding from a federal subsidy program, as a private entity, it has "freedom" to "decide whether to participate in that relationship." Moreover, New York City does not have an ownership interest in the landlord and the landlord is not required to renew its contract with HUD. Additionally, "neither HUD nor any other state housing agency has any involvement in or set guidelines for how, when, or where" the landlord was formed.

The court also noted that, the landlord's building is operated "entirely by private employees" of the landlord and the landlord is "responsible for determining who its tenants will be and for operating the building, even though it is contractually obligated to follow HUD guidelines in certain respects." HUD lacks the authority to dissolve the landlord for "failure to comply with any regulations or guidelines" and the landlord lacks any "sovereign immunity" and has the same "liabilities as other private landlords." Thus, the court found the landlord's "inclusion in the federal housing program alone does not lead to the conclusion that (landlord) is acting as a governmental unit subject to section 525."

The landlord further argued that even if it was a governmental unit, it did not violate §525 since the landlord had not "discriminated against the debtor based on her failure to pay discharge debt." The landlord had continued to act as the debtor's landlord even after the prepetition rent obligations had been discharged. After the debtor had defaulted on her obligations to pay post-petition rent, the landlord "subsequently elected to pursue its statutory remedy to recover post-petition arrears." The landlord asserted that their "outstanding arrears serving as the basis for the debtor to argue discrimination arose after the debtor's prepetition rent was discharged."

The debtor relied on a Michigan Bankruptcy Court decision for the proposition that §525 "applies to a private landlord participating" in the §8 Program. That decision cited a case which held that landlords who "merely receive public funds and are subject to governmental regulations do not qualify as governmental units did not adequately analyze the government's involvement. Nor did they consider that the entity was carrying out a governmental function – providing low income housing."

The court explained that §525 bars governmental units from "discriminating against a person with respect to certain grants solely because that person has a debt discharged under the Bankruptcy Code." The court noted that courts in the 2nd Circuit "applying section 525 have found that it protects tenants in governmental units from eviction based on prepetition discharged rent." The Bankruptcy Code defines "governmental unit" as "United States; State; Commonwealth; District; Territory; municipality; foreign state; department, agency, or instrumentality of the United States…, a State, a Commonwealth, a District, a Territory, a municipality, or a foreign state; or other form of domestic government." 11 U.S.C. §101(27) The legislative history suggests that the term "governmental unit" should be "construed broadly." Decisional precedent held that "federal credit unions, transit authorities, liquor authorities, and publicly funded housing authorities, such as the New York City Housing Authority (NYCHA), qualify as governmental units."

The court observed that a "less settled question, however, is whether a private landlord receiving (§8 Program) subsidies also qualifies as a 'governmental unit.'" The court noted that the 2nd Circuit has "suggested that a private entity does not become a 'governmental unit' merely because it participates in a subsidized housing program regulated by the federal government."

The court reviewed several decisions from other jurisdictions addressing the issue and explained that "to prevail under section 525's anti-discrimination provision, the debtor must establish that the discriminatory action was taken 'solely because' of the debtor's prior bankruptcy filing." The court further noted that if a Chapter 7 trustee rejects a lease, the lease is "no longer part of the bankruptcy estate, and the non-debtor party to the contract may generally pursue state law remedies for breach of contract, including eviction for breach of lease." Thus, §365 "authorizes landlords to pursue the state law remedy of eviction with respect to rejected leases where the tenant fails to fulfill the covenant to pay rent."

As to the "interplay between §§365 and 525 with respect to Governmental Units," the 2nd Circuit had ruled that when dealing with a "government unit", "when sections 365(b) and 525(a) come 'foot to foot' in the public housing context, section 365(b) must step aside and let section 525(a) pass." The 2nd Circuit explained that such rule furthers the purposes of the Bankruptcy Code to provide debtors "with a fresh start" and to "ensure that governmental units do not deprive debtors of grants that are essential to their fresh start."

The court found that landlords participating in the §8 Program are "not governmental units subject to section 525's non-discrimination provision." The court adopted the reasoning of a prior court decision which found that a landlord participating in federal subsidy programs, similar to the §8 Program, was not a "government unit" under §525. That decision emphasized that "HUD makes no payment to landlord's tenants and the tenants make no rental payments to or for the benefit of HUD." That decision further reasoned that "although the landlord receives a subsidy from HUD, it does not extend HUD money to the debtor and it does not collect any funds from the debtor on behalf of or for the benefit of the government." That decision further reasoned that if the tenant fails to pay rent, the harm falls upon the landlord, not the government. Here, the landlord "bears the loss of its tenant's failure to pay rent."

Thus, the court stated although the landlord received public funds from HUD and are subject to government regulations, the landlord "does not act on behalf of or for the benefit of the government." The court found it "persuasive" that the landlord is not obligated to participate in the §8 Program. Since the landlord has the "freedom to decide whether to continue participating in the (§8 Program)," the landlord "operates independently from the government, and only receives public funds subject to federal regulation when it renews its one-year lease with Section 8 tenants." The court noted that such arrangement is "different from a public housing authority whose tenancies are subject to leases obtainable only from the government."

The court also considered the "important and necessary role" that the landlord and "other landlords play in providing affordable housing to low-income residents by choosing to participate in the (§8 Program)." The court opined that holding the landlord to be a governmental unit subject to §525's non-discrimination provision "would threaten the (§8 Program) by discouraging private landlords from participating in the program for fear that tenants with substantial arrears could file for bankruptcy to prevent their landlord from pursing the state law remedy of eviction."

Accordingly, the court declined to follow the aforementioned Michigan Bankruptcy Court decision. The court believed that the Michigan decision failed to consider, "that the private landlord bears the harm for tenant's failure to pay rent under the (§8 Program) or that the landlord can choose whether to participate in the (§8 Program)." The court reasoned that those facts are "dispositive because they demonstrate that the government does not completely oversee and control the operation, administration, and maintenance of a Section 8 landlord's tenancies."

The court believed that the Michigan court had placed too much reliance on a prior court decision that held that a private tenant association "acting as a landlord for a New York City-owned building was a governmental unit because of the government's substantial control over the landlord's management and operations." In such case, the control "exerted by the government over (a) tenant association … far exceeds the level of entwinement between HUD and Section 8 (Program) landlord." For example, the city owned the building, the city could access tenant bank accounts, the city had "unhindered access to the premises, the tenant association could purchase the building from the City at a later date, the City supervised all of the tenant association activities, and the City could inspect the building's leases, records, and bills without prior approval."

Additionally, the case relied upon by the Michigan court involved rent arrears that accrued to the city before the tenant association was formed and the tenant association's ability to collect such rent "would be a windfall, and the tenant association is truly a surrogate for the City in its nonpayment proceeding." Thus, the court reasoned that the Michigan court relied on precedent with "far more involvement by the government in the tenant association's operations and management than the facts presented here."

Accordingly, the court held that the landlord is not a governmental unit subject to §525(a), lifted its stay and granted the landlord permission to "continue with its pending State Court Eviction Proceeding based on the prepetition and post-petition rent arrears." However, given the severe consequences of the court's ruling and since Bankruptcy Court decisions on the subject issue are "split", the court stayed its own decision to permit the debtor an opportunity to appeal and seek a further stay from the District Court.

Comment: Richard T. Walsh, a partner at Horing Welikson & Rosen, P.C., counsel for the landlord, advised that the tenant did not appeal the decision.

Matter of Watson, U.S. Bankruptcy Court, SDNY, Case No. 18-10164, decided Jan. 23, 2020, Glenn, J.

Commercial Landlord-Tenant—Landlord Granted Summary Judgment of Possession Based on Tenant's "Incurable Insurance Defaults"

A landlord appealed from part of an order of the Civil Court of the City of New York, which denied its motion to dismiss a tenant's affirmative defenses, for summary judgment of possession and for rent/use and occupancy in a holdover summary proceeding. The tenant cross appealed from the same order which denied its cross motion for summary judgment dismissing the petition. The Appellate Term (court), modified the trial court order by granting the landlord summary judgment of possession and dismissing the tenant's affirmative defenses. The court remanded the matter to the trial court for a hearing to determine the amount of rent/use and occupancy and reasonable attorney fees due to the landlord.

The court explained that the landlord's "motion for summary judgment of possession should have been granted based upon its unrebutted showing that tenant breached the insurance coverage requirements of the governing commercial lease agreement." From "on or about November 14, 2017 to at least June 12, 2018, tenant failed to maintain an umbrella policy with an additional $1 million limit in excess of the underlying commercial general liability (CGL) policy limits, in violation of paragraph 63 of the rider to the lease." The tenant also failed to maintain "the required workers' compensation insurance, and liability insurance relating to 'construction operations' and 'independent contractors/subcontractors'."

The court stated that even if the tenant's "general contractor, who performed a build-out of the demised premise from a restaurant/bar to a spa, was carrying adequate insurance, a 'landlord' is not required to accept a third party's performance in lieu of tenant's." The court also held that the tenant's "waiver argument was barred by the 'no waiver' clause of the lease." Additionally, the court stated that since the lease gave the tenant a "six-month rent abatement while tenant renovated the premises for its intended use, the Landlord cannot be charged with accepting rent with knowledge of tenant's insurance defaults."

The court found that an alleged statement by the former owner of the property that the tenant's insurance defaults were "'not problematic,' so long as the general contractor maintained liability insurance in the required amount and named landlord as an additional insured," was of "no probative value." The tenant had "failed to establish that (prior owner's) alleged statement was corroborated by documentary evidence or was unequivocally referable to an oral modification of the lease." The court held that such "'bald representation' raised no issue of fact." Additionally, the tenant had also failed to provide an "'acceptable excuse' for its failure to tender in admissible form, evidence that (prior owner's) statement was made." Thus, the alleged statement by the prior owner was "inadmissible hearsay."

The court also stated that an issue of fact had not been raised as to whether the current landlord had accepted rent for a significant length of time with knowledge of the tenant's insurance defaults. The landlord had acted "promptly in May 2018, within one month of its ownership of the building, to object to the adequacy to the insurance coverage prior to tenant's completion of the renovation." At or about that time, the tenant's rent check dated May 24, 2018 for the base rent for the first half of June 2018, had been "expressly rejected by landlord due to 'termination of tenancy/pending litigation' related to petitioner's prior 2018 holdover proceeding commenced against the tenant on similar grounds."

Finally, court held that the tenant's affirmative defense that the landlord had "acted in bad faith" was also insufficient to raise an issue of fact. The court concluded that the landlord had "valid grounds for terminating this commercial lease, based upon tenant's incurable insurance defaults."

159 W. 23rd LLC v. Spa Ciel De NY Corp., Appellate Term, 1st Dept., Case No. 570635/19, decided Feb. 5, 2020, Shulman, P.J., Cooper, J., All concur.

Scott E. Mollen is a partner at Herrick, Feinstein.