Delaware Business Bankruptcy Report : Delaware Business Bankruptcy Report : Morris James LLP Lawyers & Attorneys

Landlords and the Debtors entered into pre-petition leases for nonresidential real property that required prepayment of rent on first of every month. The Landlords moved for allowance as administrative expense and immediate payment of post-petition stub rent relating to that portion of   month in which bankruptcy petition was filed.  The Debtors objected and argued that (i) an administrative claim was not available under 365(d)(3) because the stub rent obligation did not arise post-petition and (ii) section 365(d)(3) or section 365(b)(1)(A), if the lease is assumed, provide the sole bases for awarding administrative claims for post-petition rent. 

The crux of the dispute was the meaning of the term “notwithstanding” as it is used in section 365(d)(3) of the Bankruptcy Code. Section 365(d)(3) requires the trustee to “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, notwithstanding section 503(b)(1).” 11 U.S.C. § 365(d)(3) (emphasis added). 

The Debtors argued that section 365(d)(3) renders section 503(b)(1) inapplicable to post-petition obligations under any unexpired lease of nonresidential real property, and therefore, the court could not allow an administrative expense claim on behalf of landlords for stub rent under section 503(b)(1). Additionally, the Debtors argued that whether the landlords’ claim for stub rent may be allowed and paid as an administrative expense claim depends on whether the Debtors assumed or rejected the leases. Debtors argued that if they rejected the leases, the stub rent would not be entitled to status as an administrative expense because the rejection would mean the claim arose pre-petition. The landlords countered Debtors’ arguments by arguing that sections 365(d)(3) and 503(b)(1) are mutually exclusive.

The Court held that section 365(d)(3) expands a landlord’s remedies for payment of post-petition rent by allowing for payment of rent obligations without requiring the landlord to file an administrative claim and seek immediate payment under 503(b)(1). This result was consistent with the Court’s prior decision in In re Valley Media, Inc., 290 B.R. 73 (Bankr. D. Del. 2003) where Judge Peter J. Walsh implicitly stated that section 365(d)(3) and 503(b)(1) are mutually exclusive and neither section trumps the other.

The Court further held that the Debtors’ ultimate assumption or rejection of the leases did not alter the Court’s determination of whether it could allow an administrative expense claim for stub rent under section 503(b)(1). The Court stated that courts routinely allow administrative expense status for claims arising from post-petition occupancy and use of real property even if the debtor has already rejected the lease or the lease expired pre-petition. Further, although the burden is on the claimant under section 503(b)(1) to establish that its asserted administrative expense claim is an actual, necessary expense of preserving the debtor’s estate, a debtor’s occupancy of the landlord’s premises is sufficient, in and of itself, to meet the burden under section 503(b)(1).

Timing of payment of a claim for administrative expense is a matter within the discretion of the bankruptcy court. Factors identified by Judge Mary F. Walrath in In re HQ Global Holdings, Inc., 282 B.R. 169, 173 (Bankr. D. Del. 2002) to consider when evaluating the timing of payment include: (i) bankruptcy’s goal of orderly and equal distribution among creditors; (ii) preventing a race for the debtor’s assets; (iii) the particular needs of the administrative claimant; and (iv) the length and expense of the case’s administration. Generally, distributions prior to plan confirmation are disallowed when the estate may not be able to pay all of the administrative expenses in full. In this case, the risk of administrative insolvency was virtually non-existent but the Court did not award immediate payment. The plan for reorganization was filed and confirmation was scheduled for October 2008. Under the proposed plan, administrative claims would be paid in full. Thus, any delay in payment would be minimal and any risk of administrative insolvency was lowered by the probable short administration of Debtors’ cases. Additional support for delaying payment was based on the Debtors’ business judgment. Although the Court declined to determine whether the HQ Global factors or the debtor’s business judgment standard applies to a determination of the timing of payment, the Court noted that a decision relating to the payment of these administrative claims is within the debtor’s ordinary course of business and is entitled to deference utilizing the section 363(b) business judgment standard.

UPDATE:  Third Circuit Affirms:  In re Goody's Family Clothing, Inc., Case No. 09-2168, (3d. Cir. June 29, 2010) (J. Ambro, J. Aldisert, and J. Roth).

The Third Circuit extrapolated two issues from the facts and law set out above: (1) whether the existence of § 365(d)(3) precludes the attempted use of § 503(b)(1) for the “stub rent;” and (2) if not, whether the “stub rent” may be considered an administrative expense pursuant to § 503(b)(1). The Third Circuit held that § 365(d)(3) does not provide the exclusive remedy for unexpired leases and that the “stub rent” was an administrative expense under § 503(b)(1) due to the Debtors’ continued occupancy of the premises in conjunction with the Debtors’ use of the premises to conduct sales of its goods.

First, the Third Circuit evaluated the plain language of § 365(d)(3) in light of its earlier interpretation of this section in Centerpoint Props. v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 268 F.3d 205 (3d Cir. 2001) and concluded that § 365(d)(3) did not preclude the use of § 503(b)(1): rather, § 365(d)(3) offered a less burdensome mechanism for recovering rent payments due and owing after a debtor filed for bankruptcy. 

In reaching this conclusion, the Third Circuit paid particular attention to the word “notwithstanding” in the phrase “notwithstanding section 503(b)(1) of this title” located within § 365(d)(3). Reasoning that “notwithstanding” means “in spite of” or “without prevention or obstruction from or by,” the Third Circuit determined that § 365(d)(3) is an exception to the administrative procedures, namely the requirements of notice, a hearing, and an actual and necessary benefit to the estate, located in § 503(b) which ordinarily apply. 

The Third Circuit bolstered the plain language argument by remarking that it comported with logic, as “it would put lessors in an awkward place if, while debtors were required to pay them on time pursuant to § 365(d)(3), accepting such a payment served also to deprive lessors of the balance of their rights under the Code.” This reading was further supported by the final sentence in § 365(d)(3), which ensures that “[a]cceptance of any [performance under this section] does not constitute waiver or relinquishment of the lessor’s rights under such lease or under this title.” 11 U.S.C. § 365(d)(3).

Second, the Third Circuit upheld granting the Landlords’ claims administrative expense treatment pursuant to § 503(b)(1). The Third Circuit was swayed by not only the continued actual possession of the premises by the Debtors, but also the store-closing sales conducted thereon, which resulted in greater than 105% recovery and were “an integral part of the bankruptcy proceedings,” and ultimately concluded that the Landlords were entitled to a reasonable “stub rent” as an actual and necessary expense for the benefit of the estate.