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Commercial tenants' strategies for avoiding or delaying rent payments

6 minute read

A closed restaurant during the outbreak of the coronavirus disease in New York City. March 26, 2020. REUTERS/Mike Segar

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June 30, 2021 - The economic damage many businesses have suffered as a result of the COVID-19 pandemic has led to an increase in commercial tenants seeking to avoid or delay making rent payments, including extending beyond the 60-day period permitted under section 365(d)(3) of the Bankruptcy Code. Additional time can prove critical for debtor-tenants, in particular for businesses such as movie theaters, restaurant or retail stores where rent comprises a large part of the post-petition expense and where they were forced to close by government mandate.

Debtor-tenants have employed at least three strategies to avoid or delay paying rent:

•Abate rent based on lease provisions (e.g. force majeure clauses) and common law doctrines such as impossibility or frustration of purpose.

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•Postpone rent through a "temporary procedures" order during which, no party — including landlords — is permitted to file motions seeking to lift the automatic stay (e.g., for non-payment of rent).

•Defer paying rent until plan confirmation or later, via an "Interim Budget" order.

Debtor-tenants have frequently sought the abatement of rent through lease provisions, such as force majeure provisions. In most of these cases, the outcome has turned on the interpretation of lease provisions, most often whether the force majeure clause excuses the duty to pay rent.

Debtors have been able to obtain a temporary abatement where the force majeure provision excuses the duty to pay rent, such as in In re Hitz Restaurant Group, In re Cinemex USA Real Estate Holdings, Inc., and F&O Scarsdale LLC. Debtors with leases that do not excuse the duty to pay rent have been denied relief, such as in CEC Entertainment, Inc.

Debtors have also sought to abate rent under the related doctrines of impossibility and frustration of purpose, based on state law, but have largely lost. Courts have found that neither doctrine applies because, among other reasons, the parties anticipated governmental shutdown regulations based on the terms in the lease, the operation of a store was not objectively impossible, or running a store less profitably or even at a deficit was not sufficient to "frustrate" the purpose of the lease or render the debtor-tenant's performance "impossible."

For example, in CEC Entertainment, Inc., Bankruptcy Judge Isgur in the Southern District of Texas denied the debtors' motion to abate rent, finding that neither doctrine applied for these reasons. Similarly, in The Gap Inc. v. Ponte Gadea New York LLC, Judge Swain in the Southern District of New York adopted nearly the same rationale.

In Edison Price Lighting, Inc., Bankruptcy Judge Drain in the Southern District of New York recognized that "there's a very good argument" that frustration of purpose and impossibility may apply during the governmental "stay in place orders," but noted that these doctrines would apply only "for the duration of those orders," which have largely been lifted. Consequently, the window for debtor-tenants to abate rent based on frustration or impossibility has likely closed.

While debtor-tenants may not be able to abate rent, they have been successful in postponing it and overcoming the limitations of section 365(d)(3), which only allows a bankruptcy court to postpone rent for a maximum of 60 days.

Several debtors have sought additional breathing room through a "temporary procedures" motion whereby for a fixed amount of time (usually a month), no hearing will be scheduled on motions seeking to lift the automatic stay, the payment of administrative expense claims, the assumption or rejection of contracts or leases, or the enforcement of section 365(d) rights to pursue a debtor for past-owed pre- or post-petition rent.

Debtors are routinely filing these motions and many courts have granted them. For example, in Cinemex USA Real Estate Holdings, Inc., Bankruptcy Judge Isicoff of the Southern District of Florida granted a 45-day window with the option for an additional 30 days upon the consent of the U.S. Trustee and counsel for the official committee of unsecured creditors. In True Religion Apparel, Inc., Bankruptcy Judge Sontchi in Delaware granted the initial application for a temporary procedures order plus three additional extensions, for a total of nearly four months.

Debtor-tenants have also sought to postpone rent through an "Interim Budget" motion, whereby the debtors are only authorized to pay certain expenses, while deferring others, including post-petition rent obligations.

For example, in Pier 1 and Bread & Butter Concepts, LLC, the bankruptcy courts granted the debtors' motion to pay certain critical expenses, while at the same time deferring the payment of rent to certain landlords.

This motion appears to be reserved for extreme cases where a debtor is teetering on the financial precipice. The Pier 1 court granted this relief, recognizing that "[t]here is no feasible alternative to the relief sought in the Motion" because "[t]he Debtors cannot operate as a going concern and produce the revenue necessary to pay rent because they have been ordered to close their business." The Bread & Butter court adopted this rationale in deferring rent payments.

Commercial landlords facing bankrupt tenants should consider the risks and options in addressing these strategies for abating or postponing rent:

First, landlords may seek to compel the tenant to assume or reject the lease. If granted, the debtor would be required to make a determination as to whether it will assume the lease, thereby agreeing to pay all defaults and future rent in full. Even if a debtor rejects the lease and owes a pre-petition damages claim, the debtor would be required to vacate from the property. This motion also could be useful in negotiating a resolution.

Second, landlords should consider the financial viability of the debtor-tenant and negotiate, including for an upfront payment on the administrative expense claim, followed by a payment of the balance at a later time. Landlords should not rely on the fact that they may be owed an administrative expense claim as commercial retail debtors may become unable to pay administrative claims over time, as happened in Pier 1. Landlords may seek to mitigate this risk by also filing a motion for adequate protection under 363(e) and seek the immediate upfront payment of some amount of rent.

Finally, landlords should look to the terms of guaranties and whether they may pursue guarantors as primary obligors. Doing so may mitigate the risk of a debtor-tenant affecting its rental obligation.

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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

Schuyler G. Carroll is a partner in Loeb & Loeb's Restructuring and Bankruptcy practice. His practice focuses primarily on Chapter 11, 15 and 7 bankruptcy proceedings; distressed acquisitions; creditors' rights enforcement; and litigation and advisory work. He can be reached at scarroll@loeb.com.

Bethany D. Simmons, a partner with the firm's Restructuring and Bankruptcy practice, focuses her practice on bankruptcy reorganization and commercial litigation, and has experience guiding debtors in health care and oil and gas industries through the stages of Chapter 11. She can be reached at bsimmons@loeb.com.

Noah Weingarten, an associate in Loeb & Loeb's Restructuring and Bankruptcy practice, provides advice on complex bankruptcy and restructuring matters. He maintains a commercial and bankruptcy litigation practice with an emphasis on bankruptcy avoidance litigation and media and entertainment disputes. He can be reached at nweingarten@loeb.com.

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