Hardball or economic air-brake: tenants seeking rent relief from COVID-19
Bankruptcy as the economic air-brake or “hardball.”
Two noteworthy items in the last twenty-four hours. Reuters reports that because of the COVID-19 pandemic, mall operators collected only 15% of April rent and trends are looking worse for May.” Kumar, “U.S. landlords, retailers play hardball,” May 11, 2020. As a result, Scott Crowe chief investment strategist at CenterSquare is reported to have said that “90% of the malls in this country won’t be here in a year.” Id.
On May 10, 2020 Judge Kevin Huennekens, bankruptcy judge for the Eastern District of Virginia, overseeing the retail bankruptcy of Pier 1 Imports, Inc., entered a Memorandum Opinion (Dkt. 637) permitting some tenants to defer making rental payments to landlords during a “Limited Operations Period,” which currently runs through May 31, 2020. (First Supplemental Order, (Dkt. 629)).
The Opinion is extremely important, in that it permitted commercial tenants to retain possession of their leased premises, without paying rent, despite Code § 365(d)(3) which ordinarily requires commercial real estate tenants to pay all of their rental obligations from and after the filing of the bankruptcy petition, and until the lease is either assumed or rejected. This obligation can be deferred for only 60 days after the filing, but “shall not be extended beyond such 60-day period.” In addition, a tenant has 120 days in which to assume the lease (and hence cure defaults and make all payments). This period can only be extended for 90 days unless landlords agree to further extensions. If the time periods are not met, the lease is deemed rejected and the tenant must “immediately surrender” the premises. § 365(d)(4)(A). The deadline to assume is September 14, 2020.
The Bankruptcy Court found that it could suspend the obligation to pay rent beyond the 60 day period, and may be willing to extend the time to assume. The Court’s willingness to do this was expressly based on the Court’s finding that “the world has changed since the filing of these Chapter 11 cases” and that the Court had the power to do so under Code § 105 which permits a court to enter any order “necessary or appropriate to carry out the provisions of this title.” Further, the Court deferred ruling on whether the rental obligations might be deferred or even eliminated under state law theories such as impossibility of performance or impracticality of performance.
What is “timely” performance. A key question is whether a bankruptcy court has the statutory authority to suspend rental payments. Code § 365(d)(3) provides that a tenant must “timely perform” its rental obligations from and after the filing of the petition. However, the Court noted that § 365(d)(3) does not provide an express remedy for a failure to do so, and that under some case law, the rent claim becomes an administrative priority. The Court cited In re Circuit City, which likewise held that “timely” payments may not mean per the lease, but per the Code. “Timely could mean whatever period for timely performance is provided by the lease terms, as the Debtors' argue. Timely could mean that payment of these administrative claims should be made with all other administrative claims—upon the effective date of the plan.” In re Circuit City Stores, Inc., 447 B.R. 475, 509 (Bankr. E.D. Va. 2009). See discussion of the remedies for failure not to pay rent in Kuney, Retail and Office Bankruptcy, ABI, (2018) 50.
Under this ruling, a rent obligation conceivably could be deferred until plan confirmation, when all administrative claims must be paid as a condition to confirmation. But if the debtor is unable to confirm a plan, and lacks the funds to pay all administrative claims, it may convert to a chapter 7, which in turn may cause landlords to lose much or all of their rent claim. Thus, the decision has serious ramifications and could alter the rights of landlords.
Statutory basis? Another statutory basis for the decision was Code § 105 which permits a bankruptcy court to enter an order necessary to carry out the provisions of Title 11. But it is unclear that § 105 is appropriate. This issue remains subject to further debate and analysis. Significant body of case law cautions against extensions and contradiction.In Law v. Siegel, 571 U.S. 415, 420-21 (2014) the Supreme Court stated that, “It is hornbook law that § 105(a) “does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.” Section 105(a) confers authority to “carry out” the provisions of the Code, but it is quite impossible to do that by taking action that the Code prohibits. But Judge Huennekens contends there is no contradiction but a preservation of his jurisdiction.
Adequate protection. The Court found that the landlords were adequately protected from loss of value. This was because the Debtors were making all insurance and utility payments. Further, the Debtors also asserted that if they are able to reopen on June 1, they will be able to make “catch-up rent payments in the middle of July.” (Order, 9.) “The Debtors have announced their plans to not only resume payment of ongoing rent obligations but to cure unpaid post-Petition Date obligations sooner than required by section 1129 of the Bankruptcy Code.” (Order, 10.)
State law theories of impossibility and frustration of purpose? The Court did not yet rule on the amount of rent that was due, and specifically stated that the Court was not deciding whether the Debtor’s performance under the leases had been excused due to impossibility, impracticability or frustration of purpose.
Yet, some of the Court’s comments reflect a possible outcome that may well relieve the tenants of the rent obligation for at least some period of time under the state law theories. For example, the Court noted that, “No constituency in these cases predicted that the world would effectively grind to a halt. But, so it did.” Emer. Ord. 2. Further, the Court noted that as of March 31,2020 “[a]t lease 33 states, 89 counties, 29 cities, the District of Columbia, and Puerto Rico [had] issued ‘stay at home’ or ‘shelter in place’ orders” effectively closing the Debtors’ stores.” (Order, 3)(emphasis added).
Balancing of competing constituent interest. The Court found that given the Debtors’ scarce resources if the Court were to grant “relief to one creditor constituency (such as landlords) it must necessarily require that another creditor constituency (such as furloughed employees) forgo the limited relief accorded them. “There is no feasible alternative to the relief sought in the Motion.” (Order, 11.) The Court perceived that without the Emergency relief there would be a destructive creditor grab as each creditor pursued its own self-interest; in essence, creditor chaos.
The Order is in the nature of a rolling order. On May 29, 2020 the Court will consider a request to extend the Limited Operations Period beyond May 31, 2020.
For further review, see Kuney, Retail and Office Bankruptcy, Amer. Bankr. Inst., 2018.