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Retail Debtors “Pausing” Post-Petition Rent Obligations During the COVID-19 Pandemic

May 19, 2020

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Since the beginning of the COVID-19 pandemic, retailers such as Modell’s Sporting Goods and Pier 1 Imports have requested to defer payment of post-bankruptcy rent to their landlords beyond the deadline imposed by the Bankruptcy Code. Bankruptcy courts have been receptive to these requests, reflecting a growing trend of bankruptcy courts using their equitable powers to stretch the Bankruptcy Code to preserve value.

Statutory Background

In 2005, Congress amended the Bankruptcy Code to require debtors to timely comply with non-residential real property lease obligations, including paying monthly rent, and shortened the time period in which a debtor must assume or reject a non-residential real property lease:

  • Bankruptcy Code Section 365(d)(3) requires debtors to remain current on their commercial lease obligations until the corresponding lease is assumed or rejected.1 That said, there is a limited exception to this rule. Section 365(d)(3) also allows bankruptcy courts to defer a debtor’s lease obligations during the first 60 days of a bankruptcy proceeding under certain conditions.2 Specifically, section 365(d)(3) states that courts may grant the temporary deferral only if: (i) it is for cause; and (ii) lease obligations are not deferred beyond the 60th day of the bankruptcy filing.3
  • Bankruptcy Code section 365(d)(4) imposes a 210-day “drop dead” period for debtors to assume or reject nonresidential real property leases.4 If a lease is not assumed by the end of the period, such lease is deemed rejected.

Once a retailer files for bankruptcy protections, landlords rely on section 365(d)(3) to collect on lease obligations during the “drop dead” period. Bankruptcy courts strictly applied section 365(d)(3)’s 60-day limitation on temporary lease obligation deferrals. But the onset of the COVID-19 pandemic resulted in retail debtors seeking and receiving rent deferments beyond section 365(d)(3)’s temporal limitations. 

The First Mover: Modell’s Sporting Goods

The trend began with Modell’s Sporting Goods. On March 23, 2020, the sporting goods retailer filed a motion seeking to suspend their chapter 11 proceedings pursuant to Bankruptcy Code sections 105 and 305.5 Section 105(a) permits a bankruptcy court to “issue any order . . . that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code, and section 305(a) authorizes bankruptcy courts to suspend all proceedings if it is in the debtors’ and creditors’ best interests.6 Modell’s sought to defer, among other obligations, their rent obligations and argued that state-imposed limitations and prohibitions forced them to reevaluate their bankruptcy strategy. Such limitations prevented them from conducting proposed going-out-of-business sales and operating their stores. The court granted the motion and suspended the proceedings through April 30, 2020, without prejudice to the debtors’ right to seek a further extension of time.

Thereafter, the debtors sought a further suspension of their chapter 11 cases through and including May 31, 2020, which would defer rent obligations over the 60-days specified in section 365(d)(3). Many of Modell’s Sporting Goods’ landlords objected, arguing that section 365(d)(3) barred the extension.7 The court held a hearing on the matter and nevertheless granted the extension over the landlords’ objections.8 While the Modell’s Sporting Goods court did not publish its reasoning, the Pier 1 Imports court faced the same legal issues, reached substantially similar conclusions, and issued a corresponding opinion.9

Pier 1 Imports Sheds Light on Section 365(d)(3)’s New Reality

About one week after Modell’s Sporting Goods filed its initial suspension motion, Pier 1 Imports filed its own emergency motion to suspend its bankruptcy proceedings and requested permission to temporarily cease making rent payments.10 Relying on the Modell’s Sporting Goods decision, the Pier 1 Imports court granted the debtors’ request to suspend rent payments to their landlords and adjourned all motions for relief from the automatic stay for 45 days.11 Thereafter, on May 5, 2020, the Pier 1 Imports court further extended the relief and deferred Pier 1 Imports’ rent payments beyond the 60-day period envisioned by section 365(d)(3).12

On May 10, the Pier 1 Imports court issued a Memorandum Opinion explaining the reasoning in the suspension orders.13 Relying on its equitable authority under Bankruptcy Code section 105(a), the court explained that there is no feasible alternative to the relief sought by the Pier 1 Imports debtors. Contrary to the landlords’ assertions, the court explained section 365(d)(3) does not give landlords a right to compel payment from the debtors.14 To the extent the debtors fail to timely pay rent, the court held landlords are only entitled to an administrative expense claim.15 Compelling the debtors to pay rent would elevate landlords’ claims above those of administrative expense claimants. Thus, the court concluded that landlords are not entitled to such superpriority status.

However, landlords may be entitled to adequate protection when bearing the burden of rent payment deferrals. In the Pier 1 Imports matter, the court ruled against adequate protection payments, however, because the debtors implemented certain measures to prevent the diminution of the landlords’ interests. The debtors committed to preserving the landlords’ properties through critical insurance, security, and utility payments and agreed to make “catch-up” payments to landlords within 2-3 months. Thus, to the extent adequate protection is required, the court concluded the aforementioned measures were sufficient to protect landlords against any diminution in value.

Lastly, the Pier 1 Imports court emphasized that “COVID-19 presents a temporary, unforeseen, and unforeseeable glitch in the administration of the Debtors’ Bankruptcy Cases.” To that end, landlords are just one of the many creditor constituencies that have to make the necessary concessions required for the debtors to maximize value for their estates. For example, DIP lenders advanced millions of dollars in financing for the month of May, and employees that survived massive furloughs had their pay reduced by 20 to 50 percent. While extraordinary in nature, the relief afforded Pier 1 Imports is the only way the court believed it could give the bankruptcy cases a chance to succeed for the benefit of all stakeholders, including landlords.

Takeaways from Cases “Pausing” Rent Obligations Due to COVID-19

  • Landlords will have less leverage than previously believed, but they are still entitled to adequate protection payments for any diminution in value of their property.

During the COVID-19 pandemic, debtors will likely continue requesting that courts extend the 60-day period for timely payment of rent and other obligations under a lease. While landlords may argue that section 365(d)(3) requires immediate payment of rent, courts will likely continue to follow the Pier 1 Imports decision to forbid landlords from compelling such payments. That said, landlords still have the right to seek adequate protection, particularly if rent suspension may diminish the leasehold’s value.

Notably, the Judicial Conference of the United States’ Budget Committee recently proposed legislation to give bankruptcy courts authority to extend and toll statutory deadlines and time periods during the COVID-19 national emergency. Landlords should monitor this proposed legislation closely, as it would likely give bankruptcy courts additional flexibility to extend section 365(d)(3)’s 60-day period.

  • Courts will endeavor to distribute the burden of COVID-19’s economic implications among all parties in interest.

Given the dramatic impact the pandemic has had on retailers’ liquidity, courts will likely look for ways to spread the burden of the pandemic among a debtor’s various stakeholders. Both the Pier 1 Imports and Modell’s Sporting Goods courts recognized the extraordinary nature of the relief they granted by deferring rent payments, but they had no other choice. Landlords provided no viable alternative that would serve the best interests of all parties while maximizing recoveries for the debtors’ estates. As the COVID-19 pandemic eases, bankruptcy courts may scrutinize similar suspension motions a lot more closely.

  • There is no substitute for early legal representation in a bankruptcy case, especially during the COVID-19 pandemic.

Engage early and with advice of counsel. In Modell’s Sporting Goods, the debtors initially sought to suspend their chapter 11 cases for sixty days, limit the filing of pleadings during that period, and permit the payment of a consent fee to certain lenders. After negotiations with certain constituents, the debtors agreed to shorten the initial suspension period, allow for broader access to the court, and allow accrual for—not immediate payment—of the consent fee to the lenders. Similarly, landlords will benefit from early participation in bankruptcy proceedings. They should actively track their tenant’s restructuring efforts and, if possible, negotiate to have rent obligations included in DIP financing orders.

The COVID-19 pandemic has many bankruptcy courts navigating through uncharted legal waters. There is no better way to protect your interests than having competent legal counsel advocating on your behalf from day 1.

1 11 U.S.C. § 365(d)(3).

2 Id.

3 Id.

4 11 U.S.C. § 365(d)(4).

5 See In re Modell’s Sporting Goods, Inc., No. 20-14179, Docket No. 115 (Bankr. D.N.J. Mar. 23, 2020).

6 11 U.S.C. §§ 105(a), 305(a).

7 See Modell’s Sporting Goods at Docket Nos. 240, 245, 251, 254, 255, 256, 257, 258, 259, 261, 262, 263, 265, 266, 268, 271, 272, 274, 276, 277, 278, and 279.

8 See id. at Docket No. 294 (Apr. 30, 2020).

9 In re Pier 1 Imports, Inc., No. 20-30805, Docket No. 637 (Bankr. E.D. Va. May 10, 2020).

10 Id. at Docket No. 438 (Mar. 31, 2020).

11 Id. at Docket No. 493 (April 6, 2020).

12 Id. at Docket No. 629 (May 5, 2020).

13 Id. at Docket No. 637 (May 10, 2020).

14 Id.; see In re Circuit City Stores, Inc., 447 B.R. 475, 510 (Bankr. E.D. Va. 2009) (explaining that “[s]ection 365(d)(3) does not provide a separate remedy to effect payment. If a debtor fails to perform its obligations under § 365(d)(3), all a Lessor has is an administrative expense claim under § 365(d)(3), not a claim entitled to superpriority.”) (citing In re Va. Packaging Supply Co., Inc., 122 B.R. 491, 494 (Bankr. E.D. Va. 1990)).

15 Most bankruptcy courts also hold that landlords should not be entitled to better treatment than other administrative claimants. See, e.g., CIT Communications Fin. Corp. v. Midway Airlines Corp. (In re Midway Airlines Corp.), 406 F.3d 229 (4th Cir. 2005); Temecula v. LPM Corp. (In re LPM Corp.), 300 F.3d 1134 (9th Cir. 2002); In re Orvco, Inc., 95 B.R. 724 (B.A.P. 9th Cir. 1989); In re Bella Logistics LLC, 583 B.R. 674 (Bankr. W.D. Tex. 2018); In re Microvideo Learning Systems, Inc., 232 B.R. 602 (Bankr. S.D.N.Y. 1999); In re Granada, 88 B.R. 369 (Bankr. D. Utah 1988); In re Dieckhaus Stationers of King of Prussia, Inc., 73 B.R. 969 (Bankr. E.D. Pa. 1987); In re Tandem Group, Inc., 61 B.R. 738 (Bankr. C.D. Cal. 1986).

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. John J. Rapisardi, an O’Melveny partner licensed to practice law in New York, Daniel S. Shamah, an OvMelveny partner licensed to practice law in New York, Jacob T. Beiswenger, an O’Melveny counsel licensed to practice law in California and New York, and Gabriel L. Olivera, an O’Melveny associate licensed to practice law in the District of Columbia, New Jersey, New York, and Puerto Rico, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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