Joe Baldiga quoted in MA Lawyers Weekly for reaction to recent decision that Tenant may withhold post-rejection rent from landlord/debtor

December 30, 2024

A commercial tenant that allegedly suffered business losses from a faulty roof but continued to occupy the property after the landlord filed for Chapter 11 bankruptcy and rejected the lease may recoup any such damages against rent still coming due under the lease, a U.S. Bankruptcy Court judge has decided.

The tenant, Middlesex Integrative Medicine, a cannabis company that operates an 80,000-square-foot marijuana “dispensary grow” facility on Leominster property owned by debtor-in-possession Mohawk Drive Corp., sought to evict MIM — which is currently in receivership — for non-payment of rent.

Meanwhile, MIM sued Mohawk Drive for failing to keep the roof in good repair, which allegedly resulted in water infiltration that destroyed its crop, causing damage far in excess of the approximately $200,000 in unpaid rent and late fees.


After Mohawk Drive filed for bankruptcy and rejected the lease, MIM argued that §365(h)(1)(A)(ii) of the U.S. Bankruptcy Code permits a tenant to offset, or recoup, alleged pre-petition, pre-rejection damages such as those it alleged here from post-rejection rent reserved under the lease. That section of the code allows a tenant to occupy the premises for the rest of a lease term after a debtor-lessor has rejected it.

Judge Christopher J. Panos agreed.

“I see no reason why, in the context of §365(h)(1)(A)(ii), prepetition, pre-rejection consequential damages, if proven, could not be asserted as an offset for rent under the lease under a theory of equitable recoupment,” he wrote.

Panos also found, however, that MIM had not yet proven its damages and would have to pay rent into escrow pending resolution of its claims.

The 16-page decision is In Re: Mohawk Drive Corp., Lawyers Weekly No. 04-017-24.

Significant findings
Mohawk Drive’s attorney, Michael B. Feinman of Andover, said Panos’ finding that MIM may equitably recoup consequential damages against ongoing rent obligations could have gone either way.

“But an important point in clarification was that the judge said there couldn’t be any consequential damages incurred post-rejection because we’re no longer under any obligation to do the work they’re claiming was the cause of their damages,” he said.

Feinman also thought it was significant that the judge recognized it would be MIM’s burden to show his client breached the lease in order to recoup anything under future rent, and especially that MIM would be required to post escrow in the interim.

“That was key from our point of view because the party on the other side otherwise has no assets to pay the rent,” he said. “[Absent the escrow], if we won, it would have been a hollow victory.”

MIM’s attorney, Nicholas B. Carter of Boston, could not be reached for comment.

Westborough bankruptcy lawyer Joseph H. Baldiga found it notable that Panos treated the debtor’s pre-petition obligation to maintain the roof and the tenant’s post-petition obligation to keep paying rent as arising from one transaction — the lease — since federal common law and Massachusetts law generally do not recognize equitable recoupment when the parties’ respective claims arise from separate transactions.

“Normally, a bankruptcy petition date is a hard cutoff of pre-petition obligations and post-petition obligations,” Baldiga said. “But by finding those could be treated as one transaction, it really does come down to a matter of fairness. How can you saddle the tenant with post-petition rent but not take into account the damages caused by the landlord’s pre-petition failure to perform?”

Adam J. Ruttenberg of Boston added that bankruptcy lawyers are used to the idea that a bankruptcy petition draws a bright line between what happened pre-petition and post-petition and “never the twain shall meet.”

But Mohawk Drive serves as a reminder that equitable recoupment exists as an exception in limited circumstances, he said.

“As a matter of equity, a creditor is essentially collecting on its pre-petition claim by reducing what it has to pay on a post-petition obligation. It was new to me that this could happen,” he said. “It’s a very surprising thing for a bankruptcy lawyer to see.”

Dueling claims
MIM entered a commercial lease with the debtor in June 2016.

Under the terms of the lease, MIM paid $38,016 a month to use the premises for cultivating and processing marijuana and marijuana-infused products.

According to MIM, the roof was not properly maintained, which allowed water to infiltrate the facility, ruining its crops and causing it significant damages.

In 2023, the debtor brought eviction proceedings in Leominster District Court for nonpayment of rent and obtained a judgment of possession.

MIM sought relief from the eviction judgment and filed its own breach of contract and Chapter 93A action in Suffolk Superior Court regarding its roof repair allegations.

That left the parties embroiled in pre-petition litigation, with the debtor asserting that MIM defaulted under the lease, and MIM asserting that the debtor’s failure to keep the roof in good repair entitled it to terminate under the “mutually dependent covenants” doctrine and that the breaches amounted to a constructive eviction.

In March 2024, the debtor filed a Chapter 11 petition in U.S. Bankruptcy Court. In response, MIM filed a claim for at least $5 million incorporating its state court complaint.

The debtor, in turn, brought an adversary proceeding seeking turnover of the leased premises.

The day of its petition, the debtor also moved to reject the lease, which the Bankruptcy Court granted.

Meanwhile, MIM’s receiver elected to remain in the premises pursuant to §365(h)(1)(A)(ii) and pay post-rejection rent owed.

MIM also sought to recoup its alleged pre-petition, pre-rejection damages against such rent becoming due under the lease.

The debtor asked the court to reject any such offset under §365(h)(1)(B) because MIM had paid no post-petition rent, nor had it itemized any amounts that it claimed to be properly offset as damage caused by the debtor’s non-performance.

Additionally, the debtor sought establishment and funding of an escrow account as a condition of any offset under §365(h)(1)(B).

Recoupment and escrow
Panos noted that relevant Bankruptcy Code provisions do not provide extensive guidance on respective rights and remedies of lessor and lessee when the lessee elects to remain in the premises after rejection of the lease.

He also noted that under §365(h), while MIM was entitled to remain in the premises for the balance of the lease term after rejection, the landlord was no longer obligated to perform under the lease beyond providing possession and rights appurtenant.

That meant the debtor was no longer obligated to keep the roof in good order or repair, though MIM could fix the roof at its own expense and offset those costs against future rent but did not do so.

The more difficult question, Panos continued, was whether MIM could offset or recoup alleged prepetition, pre-rejection damages from post-rejection rent reserved under the lease.

He found that equitable recoupment could allow for it. The equitable recoupment doctrine permits a defendant to “defend” against a claim by asserting, up to the amount of such claim, its own claim against the plaintiff arising from the same transaction.

“The Debtor asserts that the claims of MIM and rent due under the Lease do not arise from the same transaction,” Panos said. “I do not agree. Each claim arises from an obligation created by the Lease — the obligation to pay rent and the obligation to maintain the roof in good working order.”

Here, Panos continued, both debts arose from a “single integrated transaction” and it would be “inequitable” for the debtor to enjoy the fruits of that transaction without meeting its obligations as well.

Panos also emphasized, however, that MIM had not yet met its burden of proving consequential damages from a breach by the debtor.

“[T]herefore, equitable recoupment only remains a potential remedy as to which the Court has latitude in applying to fashion equitable relief,” he said. “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.”