Current Developments with Rent Obligations in Chapter 11 Bankruptcies
Prior to the COVID-19 pandemic, the Bankruptcy Code generally has been interpreted to require debtors to pay rent obligations on time under unassumed real property leases as those obligations arose post-filing and pre-rejection. This result was driven by 11 U.S.C. § 365(d)(3), which requires the debtor to “timely perform” all obligations until the lease is assumed or rejected, with one narrow exception. That exception permits the court to allow the debtor to extend the time of performance of any obligation within the first 60 days of the case but not beyond the 60-day period.
Most courts interpreting section 365(d)(3) have reasoned that the section requires the debtor to perform any obligation after filing and before rejection when the obligation arises. See, e.g., In re Burival, 613 F.3d 810, 812 (8th Cir. 2010). The failure to timely comply could lead to the court establishing an early deadline to assume or reject the lease as a remedy. See In re DBSI, Inc., 407 B.R. 159 (Bankr. D Del. 2009).
Notwithstanding this somewhat clear language, some bankruptcy courts in a few recent cases around the country have permitted debtors to suspend or postpone obligations arising post-petition, both within the initial 60-day period and beyond. Likely this is not a start of a trend but rather a creative solution to pandemic-ordered shutdowns considered temporary. Indeed, one recent opinion discussed below rejected the approach taken by other bankruptcy courts. Nevertheless, while pandemic closures continue, advisors should consider whether such relief could be available to their clients. Below is a summary of some approaches taken by the courts.
In In re Modell’s Sporting Goods, Inc., Case No. 20-14179 (Bankr. D.N.J. 2020), Modell’s was in the process of conducting liquidation sales of inventory at its retail stores when the pandemic began. Once various states issued shelter in place orders, Modell’s filed an application with the bankruptcy court seeking to suspend temporarily the chapter 11 cases pursuant to section 305 of the Bankruptcy Code. Section 305 provides for dismissal or suspension of proceedings if in the interests of creditors and the debtor. The suspension meant that debtors would not be required to pay post-petition obligations at least temporarily, including payment of many post-petition obligations such as rent. Other expenses were approved to be paid pursuant to a modified budget, and all parties were given the right to seek other or additional relief at a future hearing scheduled about one month out. Landlords were given the right to access the leased premises on reasonable notice but importantly, all proceedings in the case was suspended. See Order, Dkt. No. 166 (3/27/2020).
The bankruptcy court in In re Pier 1 Imports, Inc., 615 B.R. 196 (Bankr. E.D. Va. 2020) took a more direct tack when faced with the same issues. There, the debtor proposed to suspend operations and pay certain lease-related expenses during the suspension, but not the rent. Several landlords objected, arguing that section 365(d)(3) did not permit the debtor to suspend payment of rent. While the court noted the prior caselaw interpreting this section to refer to the time of performance under a lease’s terms, the court reasoned that the failure to pay in accordance with the lease simply resulted in the landlord having an administrative expense claim for the unpaid rent. The court noted that such administrative expense claims are not entitled to be paid sooner than other similar expenses and were not obligated to be paid until confirmation of a plan of reorganization. So long as the rent is paid in full by then, it would be considered timely paid, the court reasoned. In effect, the court reasoned, section 365(d)(3) does not provide a separate remedy for failure to comply with its terms. See id. at 202. The court also noted the extraordinary circumstances faced by the debtor in light of the pandemic and the forced closure of its retail stores and reasoned that section 105 of the Code supported its grant of relief to the debtors.
The Pier 1 decision may represent the high-water mark of this type of relief. For example, in a decision released after Pier 1, the Bankruptcy Court for the Southern District of Texas essentially rejected the Pier 1 court’s approach and found that the court had no power to allow the debtor to deviate from the obligations of section 365(d)(3). See In re CEC Entertainment, Inc., Case No. 20-33163, dkt no. 1482 (Bankr. S.D. Tex. December 14, 2020). As a result, the court rejected the debtor’s request for an order involuntarily abating or reducing the rent obligations for those landlords who filed objections to that relief. In its reasoning, the court noted the plain language of the statute. The court also noted that the legislative history of that section indicated the section was designed to relieve landlords of the burden of showing that the post-petition rent was an actual and necessary expense of preserving the estate and also meant that landlords should not be forced to involuntarily extend credit to an estate prior to assumption or rejection of the lease. Finally, considering the clear language of that section, the court noted, it had no power to alter the rent obligations using its equitable powers. Id. at 9.
As the effects of the pandemic closures begin to abate, motions to avoid section 365(d)(3)’s mandates in the face of landlord objections are unlikely to succeed. Nevertheless, advisors should consider if there are other creative solutions to suspend or delay payment of rent, including the following considerations.
Considerations to Suspend or Delay Payment of Rent
- Whether suspension of rent in the initial 60 days is warranted
- Whether section 305 relief is warranted—seeking suspension of all or most case proceedings
- Whether the lease terms’ force majeure or other contract doctrines like frustration of purpose of impossibility come into play
- Whether there is a negotiated solution available by approaching landlords for temporary relief