Courts Delay Chapter 11 Tenants' Rent Payments Due to COVID-19

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The COVID-19 pandemic has affected one of the underpinnings of the relationship between a property owner and a commercial tenant that seeks Chapter 11 protection. Section 365(d)(3) of the Bankruptcy Code requires the commercial tenant to pay rent on a timely basis during the post-filing period unless and until its lease is rejected or assumed. Section 365(d)(3) allows a Bankruptcy Court to extend for cause the time for performance for up to 60 days following the bankruptcy petition date (with the amounts arising during this initial 60-day period being treated as an administrative expense claim which would have priority over unsecured creditors). However, in response to the consequences of the COVID-19 pandemic, several Bankruptcy Courts have extended or are considering extending the time for payment of post-petition rent based on other provisions of the Bankruptcy Code for longer than 60 days notwithstanding section 365(d)(3).¹

In re: Pier 1 Imports, Inc., et al.(Bankr. E.D. Va. 2020) and In re: Modell's Sporting Goods, Inc., et al.(Bankr. D.N.J. 2020) are two examples of cases in which the Bankruptcy Courts deferred the payment of post-petition rents beyond the first 60 days of the bankruptcy case. If the debtors are able to confirm Chapter 11 plans, then the practical effect of these rulings will primarily be a delay in payment since the accrued rent would still be payable in full as a priority administrative expense claim on the effective date of a bankruptcy plan. That delay could have an adverse effect on the owner's cash flow and its near-term ability to pay property expenses and debt service. However, if the debtors are unable to confirm Chapter 11 plans, it is possible that administrative expense claims including the deferred rent will not be paid in full, leaving the owner with a shortfall in the post-petition rent amounts due to the owner.

Pier 1 filed for Chapter 11 relief on February 17, 2020. Subsequent COVID-19 related stay-at-home orders prompted the home furnishings and décor business to close 80 stores while it faced $9,400,000 in monthly rent obligations. In an Emergency Motion filed on March 31, 2020 with the U.S. Bankruptcy Court for the Eastern District of Virginia, Pier 1 requested a pause on payments to landlords, shippers, suppliers, and vendors so that it could pay only critical expenses. Pier 1 cited 11 U.S.C. § 105(a) which provides that a bankruptcy court may "issue any order, process, or judgment that is necessary to carry out the provisions of this title." Pier 1 argued that a "breathing spell" in these unusual circumstances is precisely the sort of relief the bankruptcy process was designed to provide under 11 U.S.C. § 105(a). The Court granted Pier 1's motion² and permitted some of the Pier 1 tenants to defer making rental payments to landlords through May 31, 2020. In its Opinion³, the Court reiterated Pier 1's arguments under 11 U.S.C § 105(a) and noted that landlords are entitled to an administrative expense claim should the debtors fail to timely pay rent. On June 2, 2020, the Bankruptcy Court entered an order approving Pier 1's wind down and store closings. Pier 1 intends to complete its liquidation sales by October 2020. Pursuant to the wind down order, landlords will be notified of the proposed rejection date for their stores, which may be a date beyond the applicable statutory deadline⁴, and will then have the option to opt out of that proposed date. Landlords who do not oppose the proposed rejection date will have their deferred rents paid by September 12, 2020 (together with current rent). Those landlords who opt out and require the lease to be rejected by the statutory deadline will have their deferred rent paid as administrative expense claims in connection with a Chapter 11 plan (which entails further delay and risk).

On March 11, 2020, Modell's filed for Chapter 11 bankruptcy relief. Modell's subsequently requested that the Court temporarily suspend all deadlines and activities for a period of up to 60 days and that payment of all expenses other than those that are absolutely essential (i.e., not including rent) be deferred. Noting that they were unable to conduct the necessary liquidation sales of their 134 stores and e-commerce site, Modell's cited 11 U.S.C. § 305(a), which permits the dismissal of a case or suspension of proceedings if the interests of creditors and the debtor would be better served by such dismissal or suspension. Given these unprecedented times, Modell's argued, the application of such an extraordinary remedy was warranted. Further, Modell's asserted this suspension would ultimately result in the availability of more money for distribution to creditors. The Orders⁵ granting this relief run through June 15, 2020. Pursuant to a Stipulation Regarding Post-Petition Rent⁶, the debtors agreed to pay each consenting landlord (i.e., any landlord that does not object to the Stipulation or other relevant Orders) the deferred rent as well as any additional rent through the conclusion of the store closings.

In ordinary times, the payment of post-petition rent under a commercial lease prior to rejection was considered an absolute requirement, subject only to the potential 60 day deferment expressly contemplated by 11 U.S.C. § 365(d)(3). But bankruptcy courts are courts of equity and extraordinary times like the pandemic have resulted in some courts adopting some flexibility around those ordinarily strict requirements, a trend that very well may continue.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.