THE AMERICAN LAW INSTITUTE Continuing Legal Education. Protecting the Landlord in a Tenant Bankruptcy: Selected Issues and Strategies for Getting Paid

Transcription

1 41 THE AMERICAN LAW INSTITUTE Continuing Legal Education Protecting the Landlord in a Tenant Bankruptcy: Selected Issues and Strategies for Getting Paid Presented with the American College of Real Estate Lawyers (ACREL) May 22, 2013 Telephone Seminar/Audio Webcast Selected Bankruptcy Issues for Landlords and Tenants: Getting Paid ("Stub Rent" & Claims) By David L. Pollack Ballard Spahr LLP Philadelphia, PA

2 42 2

3 43 SELECTED BANKRUPTCY ISSUES FOR LANDLORDS AND TENANTS: GETTING PAID ("STUB RENT" & CLAIMS) David L. Pollack 1 Partner, Ballard Spahr LLP Philadelphia, PA Introduction This paper addresses certain of the issues involved with securing the payment of rent and the processing of claims when a landlord or a tenant files for bankruptcy. The paper focuses on only a few of the issues that arise on a regular basis and which are subject to differing interpretations by courts throughout the country. Indeed, as will be noted below, in many cases interpretations vary even within a single federal circuit and the various districts within that circuit. It is well settled that a judge in a multi-judge district is not bound by the holdings of a single district court judge within that district---and that principle is certainly evident from the decisions of numerous bankruptcy courts throughout the land. The purpose of this paper is to lay out a blueprint for some of the issues and perhaps entice drafters of leases to think about ways to make their documents address the issues in a manner most beneficial to their clients. I. Relevant Bankruptcy Code Sections The following sections of the Bankruptcy Code (the Code ) are those that are most pertinent to the discussion below. However, these are not the only sections that impact decisions regarding payments and claims. A. Section Executory Contracts and Unexpired Leases Section 365 is the primary section which details a debtor s rights and obligations regarding its leases, including assumption, assignment and rejection. The provisions of this section, particularly with regard to a debtor s duty to timely perform its obligations, have been the subject of much litigation. This section also sets forth the rights of a tenant when a landlord files for protection under the Code. (See Appendix for relevant text of this Section.) B. Section 502 Unsecured Claims Section 502 pertains to the allowance of claims and interests. Subsection (b) of Section 502 limits certain claims, with subsection 502(b)(6) placing a cap on the claims of a lessor resulting from the termination of a lease. (See Appendix for relevant text of this Section). 1 The author wishes to acknowledge the significant contribution to the research and writing of this paper by Sarah Schindler-Williams, an associate in the Bankruptcy, Reorganization and Capital Recovery Group in Ballard Spahr LLP s Philadelphia office, as well as the contribution of Kaitlin Picco, an associate in the Labor and Employment Group (formerly an associate in the Real Estate Department) also in Ballard Spahr LLP s Philadelphia office, to the research of this paper. This project could not have been completed without their assistance.

4 44 C. Section 503 Administrative Claims Section 503 pertains to the allowance of administrative expenses, which expenses have a priority status in the distribution of a debtor s estate. Section 503(b)(7) limits the administrative claim of a landlord when a lease is assumed and then rejected. (See Appendix for relevant text of this Section.) II. Post-Petition Rent Obligations The Debtor-Tenant and Rent and Stub Rent 2 Bankruptcy Code Section 365 provides for the timely performance of all obligations of the debtor under any unexpired lease of non-residential real property from and after the order for relief until the lease is assumed or rejected. Unfortunately, however, the drafters of the Code have left us without definitions of key terms such as obligations, timely and even rent. The enforcement, and indeed the meaning, of this section has been left to judicial interpretation. As the reader will discover, a somewhat inconsistent body of law has developed among the various federal circuits. 365(d)(3) The Big Dispute Accrual/Proration Method vs. Billing Date Approach Under A significant issue with which many courts have struggled concerns what Congress meant from a timing standpoint when it said that the debtor must timely perform the obligations arising from and after the order for relief. Some courts have decided the issue based upon the time that the obligation to pay rent, or some other amount, arose, while others have addressed the issue based upon the time that the obligation accrued. This accrual/payment debate often has a significant impact on both landlords and tenants. In cases where there are large monthly rental obligations, the ability to defer rental payments often provides a debtor with significant post-petition financing. In both the Linens N Things and the Circuit City cases the ability to defer payment of rent for the month in which the case was filed resulted in each of those debtors being provided with what was essentially more than $25MM of interest free, unsecured financing. Consider the following hypothetical: rent under the lease is due on the 1st day of March and tenant files for bankruptcy on March 5 th. Rent for the first four days of March is a pre-petition obligation (some debtors would argue five days). The question facing courts is whether, and if so when, the landlord can recover stub rent pursuant to 365(d)(3) for March 5th through the 31st. Courts are split on this issue, adopting either the proration or accrual approach versus the billing date approach. 2 Rent generally means all items referred to as rent or additional rent under the lease, although some courts have limited the items that may be included in that term for certain purposes. For example, many courts rule that metered utilities based on usage are not rent for rejection claim purposes, although they are rent for post-petition obligation purposes. However, some courts have ruled that a set utility charge of x dollars per month may be included in the rent that is due as part of a rejection damage claim. Stub rent is the term used for the rent due from the date of entry of the order for relief on a debtor s bankruptcy petition through the end of the month in which the petition was filed. 2

5 45 While analyzing this issue the reader should also consider whether or not lease language could be developed which would have the effect of requiring the payment of partial monthly rental based upon various trigger events, such as a bankruptcy filing, without doing injustice to other provisions of the lease requiring absolute payment of monthly rentals in full. One landlord has added the following language to its lease form. Will it work? Insolvency. Notwithstanding Tenant s obligation to pay Minimum Rent, Percentage Rent, and Additional Rent as of the first day of each month during the Term, in the event that an insolvency, bankruptcy or similar proceeding is filed by or against Tenant or Guarantor (if any), Tenant shall be obligated to pay all such Minimum Rent, Percentage Rent, and Additional Rent on a ratable basis from the date of the commencement of any such proceeding through the end of the month in which such proceeding is commenced. Timing of the Payment of Stub Rent Proration/Accrual Approach: Under the proration approach, the obligation to pay rent is considered to arise on each day the tenant occupies the leased premises. Accordingly, 365(d)(3) requires timely payment of the pro-rata portion of stub rent for the first partial month from the date the order for relief is entered, regardless of the date on which the rent was due. Under this approach, the debtor in the hypothetical would be obligated to pay stub rent for the period from March 5th- 31st. The following are some of the courts which have adopted the proration approach: 7th Cir.: In re Handy Andy Home Improvement Centers, 144 F.3d 1125 (7th Cir. 1998) (endorsing a broad interpretation of 365(d)(3) as requiring proration of a lease obligation)(proration of taxes between the prepetition period and postpetition period even though taxes were due postpetition); 9th Cir.: In re Treesource Indus., Inc., 363 F.3d 994, 998 (9th Cir. 2004) (noting that rent and tax liabilities accrue over time); 10th Cir.: In re Furr's Supermarkets, Inc., 283 B.R. 60 (10th Cir. BAP 2002); C.D. Cal. In re: The Leather Factory, Inc. Case No. 1:05-bk GM, July 9, 2012, C.D. Cal. SFV Div); S.D.N.Y.: Newman v. McCrory Corp. (In re McCrory Corp.), 210 B.R. 934, 940 (S.D.N.Y. 1997) (proration of real estate taxes); In re Stone Barn Manhattan LLC, B.R. 359 (Bankr. S.D.N.Y. 2008) (proration of stub rent for first month after petition date); In re Ames Dep't Stores, Inc., 306 B.R. 43, (Bankr. S.D.N.Y. 2004) (holding that 365(d)(3) is ambiguous and adopting a proration approach to determine the amount of post-petition rental obligations); D. Mass.: In re Learningsmith, Inc., 253 B.R. 131, 133 (Bankr. D. Mass. 2000) (applying proration approach to tax obligations); In re All For a Dollar, Inc., 174 B.R. 358 (Bankr. D. Mass. 1994) (same); and D. Md.: Heathcon 3 The opinion of Judge Gropper in the Stone Barn case provides a particularly thorough review of the law on this subject. In addition, see the very recent decision of Judge Mund in The Leather Factory, cited above. 3