Bankruptcies: Abatement of Rent During the Pandemic

Bankruptcies:  Abatement of Rent During the Pandemic

2020 has not been kind to landlords, restaurants, and other segments of the retail industry. Commercial landlords need rents to pay the property taxes, insurance and mortgage, which may be guarantied by the owners of the corporate landlord. Commercial tenants need retail sales to pay the rent to those landlords, which payment obligation may be guarantied by the owners of the retail tenant. So, the pain goes deep on all sides.
Many big retail tenants took the audacious move of suing landlords across the country in hopes of a sympathetic judge giving the tenant some sort of break, arguing the Force Majeure and Frustration of Purposes clauses in the lease abated the tenant’s rent obligations. In some cases, that was a ploy to see if the landlord would cave under the pressure of litigation, which was the case with Old Navy and The Gap in lawsuits across the country. In particular, Old Navy/The Gap tenants filed a lawsuit in Los Angeles Superior Court, arguing that Force Majeure allowed them to abate their rental obligations. While a judge in New York had entered an injunction prohibiting The Gap’s landlord from terminating the lease for non-payment, we (Epps & Coulson, LLP) opposed The Gap and Old Navy’s efforts here in LA, resulting in the tenants paying the rent due and dismissing the case.
But other big retailers have had more luck with other lawsuits. Pier 1 Imports, Inc. filed bankruptcy in the Eastern District of Virginia, expecting to confirm a plan of reorganization in sixty days. That did not happen – COVID hit. And in May, 2020, bankruptcy Judge Huennekens entered an order stating that “[t]he world has changed since the filing of these chapter 11 cases,” and noting that the debtor took “actions to preserve liquidity, including furloughing employees, closing stores, decreasing salaries, and reaching out to every landlord to negotiate a consensual rent deferral;” but the debtor needed more relief from the Court and asked for an order for debtor to pay only “critical expenses,” of which full rental payments to every landlord was not one.
It was a tricky argument: Pier 1 did not request the Court abolish its obligation to pay rent. Rent still accrued under the terms of the applicable leases and Pier 1 sought only to delay payment of certain accrued but unpaid rent obligations during a limited operations period.
Most courts have not provided relief to the tenant under the force majeure arguments, but the terms of the lease have been the focus of the court review. The onslaught of bankruptcies has begun, and more bankruptcy courts will be weighing in on these issues. For instance, a bankruptcy judge in Houston, Texas stated in a bankruptcy filed by entities that operate Chuck E. Cheese restaurants, that neither the Bankruptcy Code nor the doctrines of force majeure or frustration of purpose enable a reorganizing debtor to abate the payment of rent as a consequence of the pandemic. Neither the Bankruptcy Code nor state law permits reducing rent when government regulations restrict a debtor’s ability to generate income, per Judge Isgur.

In that Chuck E. Cheese bankruptcy case, the chain of restaurants filed for bankruptcy in June, seeking to reorganize and come out of bankruptcy a stronger, more financially stable company.  Then, in August, the restaurant chain filed a motion seeking to get an order of abatement (forgiveness) of rent, arguing that the governmental regulations closed down operation of some restaurants.  And, while some of the landlords for the restaurant chain granted concessions, six landlords objected to the debtor’s request.

Bankruptcy Judge Isgur agreed with the landlords in reviewing the various Bankruptcy Code sections, first Section 365(d)(3), which requires “timely [performance of] all the obligations of the debtor . . . arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected The court may extend, for cause, the time for performance of any such obligation that arises within 60 days after the date of the order for relief, but the time for performance shall not be extended beyond such 60-day period.”

Saying that he disagreed “on the margins” with the May Order by Bankruptcy Judge Huennekens noted above, Judge Isgur decided that Section 365(d) “expressly prohibits delays [payment of rent] beyond sixty days after the order for relief [i.e., the date of the bankruptcy filing].  The Court cannot override that statutory mandate.”  To the extent that the section might have afforded some relief immediately after the debtor commenced reorganizing in chapter 11, “[t]hat period has expired.”  Judge Isgur also addressed the force majeure clauses in the leases. Although the clauses might have given the debtor relief in some circumstances, they were all virtually identical in affording no relief from the payment of rent.

Chuck E. Cheese fared no better by arguing frustration of purpose in its bankruptcy filing.  If it were applicable, the remedy under state law would have been rescission, not abatement of rent.  Furthermore, the allocations of risk in the force majeure clauses superseded the doctrine of frustration of purpose and frustration of purpose only applies when there has been a practically total destruction of the value of performance, a circumstance not resulting from the pandemic.

In sum, Judge Isgur found nothing in the Bankruptcy Code or in the doctrines of force majeure or frustration of purpose justifying abatement of the restaurant chain’s obligation to pay rent.  So, while a couple of rulings do not dictate what happens everywhere in all courts, the law appears to be crystalizing around tenants being required to pay full rents, albeit, in a somewhat delayed fashion if the tenant files bankruptcy.

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Information contained in this Memo is intended for informational and educational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.  It is considered advertising under laws of some states.  Epps & Coulson, LLP encourages you to call us to discuss these matters as they apply to you or your business.