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January 12, 2023

Bankruptcy Basics for Retail Landlords

Issue 8—"Real Property Leases: Debtor Obligations in Retail Bankruptcy Cases"

Our last issue of Bankruptcy Basics addressed the timing of a debtor-tenant’s assumption, assumption and assignment, or rejection of its leases in a retail bankruptcy case. This issue will explore the Bankruptcy Code’s requirement of the debtor’s timely performance of its leasehold obligations pending its lease disposition decision.

Debtor-Tenant’s Timely Performance Requirement

The Bankruptcy Code mandates that a debtor-tenant (or trustee) “timely perform” all monetary and nonmonetary obligations arising under a lease of nonresidential real property (e.g., a shopping center lease) from and after the filing of the bankruptcy case. Commercial landlords are compelled to provide their property and services under their leases following the bankruptcy filing pending the debtor’s decision to assume or reject. The timely performance requirement is how Congress intended to address this financial burden imposed on commercial landlords.

Bankruptcy Courts have disagreed regarding the meaning of timely performance of all obligations. Does “all obligations” require that the obligations that first come due from and after the bankruptcy filing be paid (the “performance date” or “due date” approach)? Alternatively, must the obligations merely accrue from and after the filing (the “accrual” or “proration” approach)? Under the accrual/proration approach, rent, real estate taxes, and all other additional rent that relates, in part or in whole, to the post-bankruptcy, pre-rejection time periods must be paid irrespective of when they came due.

The timely performance requirement is particularly important in addressing “stub rent,” i.e., all rent and additional rent that accrues during the first month of a bankruptcy case from and after the filing of the case. Rent is often due on the first day of the month. If the case is filed on the second day, must the debtor pay prorated rent that accrued from the second of the month through the end of the month? In jurisdictions that follow the accrual/proration approach, this stub rent must typically be paid. However, in jurisdictions that follow the performance date approach, the timely performance requirement would not mandate the payment of stub rent. Nonetheless, certain Bankruptcy Courts in these jurisdictions have granted landlords’ requests that stub rent be given elevated (administrative expense priority) status based on the benefit the leases and premises provided to the bankruptcy estate. The timing of the debtor’s payment of the stub rent is then left to the discretion of the Bankruptcy Court if the parties do not agree, and the debtor must pay outstanding undisputed administrative expense claims (e.g., post-petition rent) in full when a court-approved Chapter 11 plan becomes effective.

It’s critical for retail landlords to know the prevailing approach to the timely performance requirement very early in their retail tenants’ bankruptcy cases, as this may influence their strategy with regard to the tenants’ first-day motions.

Extension of Debtor-Tenant’s Timely Performance Requirement

The debtor-tenant or trustee can request an extension of the time to perform any obligation under a commercial lease that arises within 60 days of the bankruptcy filing for “cause” shown. However, the time to perform cannot be extended beyond this 60-day period. During the height of the COVID-19 pandemic, these extensions were often sought and granted, especially when stores were closed.

In cases filed under Subchapter V of Chapter 11 (a subpart of Chapter 11 for small businesses with total debts of $7.5 million or less), debtors could seek two 60-day extensions of their statutory obligation to timely perform in circumstances where material financial hardship due to COVID-19 existed. However, this provision was unique to Subchapter V cases and sunsetted on December 27, 2022. Subchapter V debtors are now left with the one potential 60-day extension that’s available to other Chapter 11 debtors.

Now that we’ve explained the typical process and applicable law during a retail debtor’s bankruptcy case until it makes lease decisions, we’ll turn to the requirements for assuming or assuming and assigning leases in the next two issues of Bankruptcy Basics for Retail Landlords.
 

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