Don't Flub "Stub" Rent: Some Thoughts on Code Section 365(d)(3) from Yitzhak Greenberg

One of blogging's many benefits is in meeting people I would not have otherwise met.  Coming off an extended personal--and blogging--vacation, and with the three-week fall cycle in the Jewish Holidays fast approaching (not to mention my appeal brief in GM due next Wednesday and a chunk of other work), I'm thankful that one of the people I've recently met--Yitzhak Greenberg--has offered to author a guest post for the blog.  Yitzhak is associated with the Law Offices of Gabriel Del Virginia in New York City.  His practice is focused on bankruptcy, including the representation of landlords and tenants in bankruptcy.  He previously worked for a prominent New York City bankruptcy boutique and clerked after law school for Bankruptcy Judge Arthur J. Gonzalez, of Chrysler, Enron, and Worldcom fame.  He was selected by Fordham University School of Law, his alma mater, as a Centennial Fellow, where his responsibilities included assisting in the drafting of The Final Report to the Chief Judge of the State of New York: The Commission to Promote Confidence in Judicial Elections (a topic of considerable interest to Retired Justice Sandra Day O'Connor).  He also just authored the lead article for this month's The Bankruptcy Strategist, File for Chapter 11, Get the First Month’s Rent Free?

If anyone knows anything about "stub" rent, it's Yitzhak, and I thank him for graciously providing us with his thoughtful analysis of this thorny issue of law in this post, which he entitles: 

In re Sportsman's: The Death Knell for Stub Rent?

 

A recent Delaware Bankruptcy Court decision, In re Sportsman's Warehouse, Inc., 2009WL 2382625 (Bankr. D. Del. 2009), held that Bankruptcy Code § 365(d)(3) does not require the timely payment of stub rent, casting a shadow over the hope created by In re Goody’s Family Clothing, Inc., 401 B.R. 656 (D. Del. 2009).  Prior to Goody's, it was presumed that courts in the Third, Sixth and Seventh Circuits would not require the payment of stub rent pursuant to § 365(d)(3).  Then Goody’s was handed down, supporting a reading of § 365(d)(3) that required the timely payment of "stub" rent.  While Goody’s, decided by a Delaware District Court, focused on case law in Third Circuit, its logic extends to the Sixth and Seventh CircuitsIn light of Judge Posner’s opinion in In re Handy Andy Home Improvement Centers, Inc., 144 F.3d 1125 (7th Cir. 1998), courts in the Seventh Circuit may be particularly receptive to Goody’s.

"Stub" Rent

"Stub" rent is “the rent for the interim period between the day the order for relief was entered in the bankruptcy case and the end of that month.”  In re Stone Barn Manhattan LLC,  398 B.R. 359, 360-61 (Bankr. S.D.N.Y. 2008).  Stub rent issues arise because debtors generally file after the first of the month and prepayment of rent is due on the first of the month. § 365(d)(3) requires that the trustee “timely perform 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. . .”  Congress passed § 365(d)(3) to relieve landlords of the uncertainty of collecting rent fixed in the lease in full, promptly, and without legal expense during the awkward postpetition prerejection period.”  HA-LO Industries, Inc. v. CenterPoint Properties Trust, 342 F.3d 794, 799 (7th Cir. 2003).

Courts [even in the same district] have differed on whether an obligation to pay rent ‘arises’ on the day that rent is due (the ‘billing-date approach’), or on each day the tenant occupies the leased premises (the ‘proration approach’).”  Goody's, 401 B.R. at 663.  Courts adopting the proration approach conclude that stub rent arises during the post petition pre rejection period, and that § 365(d)(3) requires timely payment of stub rent.  Courts adopting the billing date approach conclude that stub rent arises prepetition.  

The Fall of Handy Andy and Decline of Proration in the Third, Sixth and Seventh Circuits.

While the Circuit Courts have not addressed the exact issue of stub rent, the Third, Sixth and Seventh Circuits have addressed § 365(d)(3) in other contexts. “  In re Handy Andy Home Improvement Centers, Inc., 144 F.3d 1125 (7th Cir. 1998)], [t]he Seventh Circuit Court of Appeals was the first Circuit Court to address § 365(d)(3).  Although the case involved the proration of taxes payable by the tenant-debtor under a commercial lease, Judge Posner's opinion endorsed a broad construction of § 365(d)(3) as requiring the proration of a lease obligation.”  Stone Barn, 398 B.R. at 362 (internal citations omitted).  However, the Seventh Circuit panel in HA-LO (with no overlap to the Handy Andy panel) adopted the billing date approach for post rejection rent, essentially eviscerating Handy Andy.

In Ha-Lo, the debtor rejected the lease on the fourth day of the month.  The Ha-Lo panel held that § 365(d)(3) required the debtor to timely pay the entire month’s rent because the rent arose on the first day of the month.  Ha-Lo relied upon the Sixth Circuit decision addressing post rejection rent.  See Koenig Sporting Goods, Inc. v. Morse Road Co., 203 F.3d 986, 989 (6th Cir. 2000) (holding that for the purposes of § 365(d)(3), the obligation to pay rent arose on the first of the month).

In In re Montgomery Ward Holding Corp., 268 F.3d 205, 209 (3d Cir. 2001), the Third Circuit followed suit adopting the billing date approach.  In Montgomery Ward, pursuant to the lease, the debtor was billed for taxes, including taxes that were accrued pre petition, during the post petition pre-rejection period.  The Third Circuit held that the debtor “had to pay the whole tax bill because, under the lease, the bill had become due and therefore arose, post-petition.”  Goody’s, 401 B.R. at 664.

Nevertheless, courts in these Circuits, generally, did not give a debtor a free ride and allowed an administrative claim for stub rent.  See Stone Barn, 398 B.R. at 367 (collecting cases); but see, e.g., In re Baby N' Kids, 2007 WL 1218768 (E.D. Mich. Apr. 24 2007).  Some courts went a step further, finding that if the Debtor occupied the premises, the lease’s rental-rate reflects the benefit received by the Debtor and, as such, these courts fixed the administrative claim in the amount of the rental rate.  See, e.g., Goody’s, 401 B.R. at 674 .

Goody’s: Hope for Landlords?

In Goody’s, the debtor appealed the bankruptcy court’s allowance of an administrative claim for stub rent.  On appeal, the District Court upheld the administrative claim and, therefore, was not required to decide the § 365(d)(3) issue.  However, Goody’s provided three ways to reconcile Montgomery Ward and the timely payment of stub rent: 

(i) “[R]ent might be viewed generally as a unique sort of obligation that “arises” each day of a tenant's occupancy.” Goody's, 401 B.R. at 664.  If the debtor fails to timely pay on the first of the month, “the month's rent obligation arises again, in full,… on every subsequent day of that month.” Id.;

(ii) The rent actually is due and arises during or at the end of the grace period.  Thus, if the grace period occurs or expires during the post petition pre petition period, a debtor is required to pay the entire month’s rent under § 365(d)(3); and

(iii) Default penalties create a “new obligation” and if the penalty is due during the post petition pre petition period,a debtor is required to pay the delinquent rent and penalties under § 365(d)(3). Id.

Goody’s noted that, as a matter of policy, it is “a perverse result that debtor-tenants could use § 365(d)(3) offensively to avoid timely rent payments.”  Id.  Moreover, Goody’s found it perplexing that the “statute's impact would turn upon such insignificant lease-drafting choices” of whether the rent was due daily, monthly or yearly.  Id.  “If commercial leases require full payment of the total rent obligation, with amortization in monthly installments … the entire rent obligation ‘arises’ pre-petition, thus depriving § 365(d)(3) of any practical effect.  Conversely, if a lease required that rent be due each day (say, allowing monthly payments for convenience), then § 365(d)(3) would presumably require full payment.”  Id.

The Seventh Circuit.

Judge Posner’s unequivocal support for the proration approach provides a powerful platform for landlords in the in the Seventh Circuit to seek stub rent premised on Goody’s.  Moreover, Ha-Lo focused on the debtor’s control over post petition rent.  A debtor has control over the timing of the rejection of a lease and could reject a lease on the last day of the previous month and not be liable for the next month’s rent.  In contrast, a landlord does not control the day that a debtor files its petition or rejects the lease.  But see In re UAL Corp., 291 B.R. 121 (Bankr. N. D. Ill. 2003) (post Handy Andy and pre Ha-Lo) (holding that § 365(d)(3) does not require the timely of payment of stub rent).

Sportsman’s.

Sportsman’s dimmed landlords’ expectations.  Most notable was the absence of any mention of Goody’s discussion of reconciling the timely payment of stub rent with Montgomery Ward.   In reliance upon the Goody’s lower (bankruptcy) court decision, Sportsman held that the debtor's obligation to pay that rent arose pre-petition and the stub rent is not allowable under section 365(d)(3).  Moreover, Sportsman held that the per se rule (the administrative claim is identical to the rental rate) advanced by Goody’s is a misapplication of the law.  Sportsman also held that a debtor can require an evidentiary trial through introducing evidence that the benefit to the estate is lower than the contract rent, including that “the contract rate fair market value of rent is less than the contract rent.”  Sportsman's WL 2382625 at ** 5-6.  Sportsman's thereby not only stripped the landlord of the § 365(d)(3) claim, it required that the landlord to go through the expense of an evidentiary hearing to receive any payment for stub rent.


© Steve Jakubowski 2009 (except for article, which is © Yitz Greenberg 2009)


 

 
Written By:Bob Pope On January 16, 2010 12:46 PM

Hyothetical: Landlord terminates lease 3 days prior to Ch. 11 petition. Debtor wants location and pays, two days after the petition was filed, an amount that equals the rent. The lease is rejected at the end of the third month. No more rent was paid.

Landlord files for allowance and payment of administrative claim for the last two months for which no rent was paid.

Debtor raises "stub rent".

Having made payment for occupancy of the premises for the entire month (pre and post petition)in which the petition was filed, Debtor has waived any ability to assert stub rent.

Stub rent only applies to the unpaid amounts due.

A Debtor's voluntary payment for a period that would have qualified for "stub" treatment (had the payment not occurred) removes the issue from the statute's coverage, unpaid rent obligations.

Thoughts or Comments?