Landlords Beware: Pandemic Alters Post-Petition Rent in Bankruptcy

Both commercial landlords and tenants continue to struggle from governmental lockdowns and financial pressures. Recent bankruptcy decisions have added an additional layer of financial distress on commercial landlords by: (i) reducing commercial tenants' rent based on the subject lease's force majeure provision and governmental pandemic orders and (2) ignoring commercial tenants' requirement of timely payment of post-bankruptcy rent and allowing commercial tenants to "pause" payment of rent consistent with the governmental “stay” orders issued because of the COVID-19 pandemic.
 
Commercial Tenant Successfully Reduces Rent Based on Force Majeure

Recently, in In re Hitz Restaurant Group, No. BR 20 B 05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 3, 2020), the United States Bankruptcy Court for the Northern District of Illinois considered whether a restaurant tenant could successfully invoke a force majeure provision in a lease (which may allow a party to suspend or excuse its performance for certain expressly enumerated circumstances beyond the party's control), to avoid the tenant's rental payment.
 
The force majeure provision in the subject lease before the Court in Hitz Restaurant Group provided: The tenant argued that Illinois Governor Pritzker’s Executive Order suspending “on-premises consumption” was a force majeure event that excused its performance under the lease. The Hitz Restaurant Group court first compared the Executive Order to the lease and held that the government action hindered the tenant’s ability to offer “on-premises’ consumption of food and beverages.” But, the court noted, the Executive Order “did not prohibit all restaurant operations in Illinois,” and expressly allowed “take-out, curbside pick-up, and delivery services.” The Hitz Restaurant Group court estimated that, while 75% of the restaurant’s kitchen capacity consisted of dining room and bar service and was rendered unusable by the Executive Order, at least 25% was still usable for carry-out, curbside pickup, and delivery. Therefore, the court concluded the tenant owed at least 25% of the rent, and the monthly rental payments due thereafter “are likely to increase as the government’s shut-down restrictions are gradually lifted.” The court’s decision emphasized that the effect of the force majeure clause depends on a careful comparison of the terms of the force majeure language with the government action that frustrates the execution of the contractual promises.
 
Like the debtor-tenant in the Hitz Restaurant Group case, national retailer Victoria’s Secret filed suit against its landlord in New York state court to obtain relief from its $938,000 monthly rent obligation for its flagship store in New York City’s Herald Square.  Whether Victoria's Secret will be similarly successful remains subject to judicial determination.

Commercial Tenants Granted “Pauses” in Payment of Tenant Rent Despite Bankruptcy Code's Requirement of Timely Rent

In its chapter 11 bankruptcy case pending in New Jersey, In re Modell’s Sporting Goods Inc., et al. (Bankr. N.J. Case No. 20-14179), Modell’s Sporting Goods filed a motion to suspend its Chapter 11 proceedings, including its obligation to pay timely rent to landlords as required under the Bankruptcy Code. In its motion, Modell’s asserted it should not be required to pay rent during the pandemic because changes in state and local laws had forced it to change its business model significantly. The Modell's court granted the motion and suspended Modell’s rent payment obligations through mid-June 2020.

Similarly, in In re Pier 1 Imports, Inc., et al. (Bankr. E.D. Va. Case No. 20-30805), Pier 1 Imports filed an emergency motion to suspend its rent payment obligations in its chapter 11 bankruptcy case pending in the United States Bankruptcy Court for the Eastern District of Virginia. The court granted Pier 1's request to cease paying rent to its landlords on a temporary basis. The Virginia bankruptcy court found that “COVID-19 presents a temporary, unforeseen, and unforeseeable glitch in the administration of the Debtors’ Bankruptcy Cases.” The court added that, given the strained circumstances in which retailers are, it would not require Pier 1 to allocate its already-scarce resources to landlords, as opposed to other creditors. However, the court did not determine whether the current pandemic could be used to excuse the tenant’s obligations entirely, noting that it was not deciding “whether the government-mandated closures constitute a taking sufficient to merit the non-payment of rent.”

While the Pier 1 and Modell’s cases sound innocuous, their holdings are contrary to one of the fundamental protections afforded to landlords under the Bankruptcy Code—tenant debtors are statutorily required to continue paying rent under unexpired leases during the bankruptcy case until rejection. The court in Pier 1 found that, despite the Bankruptcy Code’s mandate that landlords receive timely rent in bankruptcy, the Pier 1 debtors did not have to comply with the Bankruptcy Code and pay the post-petition rent timely. In doing so, the court acknowledged and did not alter landlords' ability to seek priority in payment for these unpaid amounts under the Bankruptcy Code, subject to applicable defenses. Whether Pier 1 or Modell's will assert a defense to rent payment, such as impossibility or force majeure similar to Hitz Restaurant Group, remains to be seen.

Commercial Landlord Commences Suit in State Court

During the first few months of the pandemic, many commercial tenants did not pay rent. Evictions were paused, and many landlords were forced to sit idle. Commercial bankruptcies are now on the rise, the pause in evictions is ending, and landlords are no longer willing to wait for rent to be paid.

Earlier this month in Delaware state court, Simon Property Group, one of the nation’s largest commercial property operators, sued the Gap, one of its largest tenants, for failure to pay rent after the Gap indicated it would not pay due to pandemic closures. Whether the Gap asserts force majeure or some common law equivalent, fully litigates the suit, settles, or files for bankruptcy, also remains to be seen.

Know Your Leases and Monitor Judicial Decisions

It is paramount for both landlords and tenants to understand their rights under the express terms of the lease and applicable law and closely monitor how current case law affects their rights, including the enforcement of force majeure provisions in commercial real estate leases. There will be many cases across the country deciphering the impact of force majeure provisions, common law doctrines to excuse performance, and COVID-19. Being mindful of these decisions and your lease documents, and proactive in approach, will protect your investment and recovery.

For questions about tenant obligations to commercial landlords, bankruptcy, and force majeure clauses, please contact Ice Miller Bankruptcy and Restructuring attorneys John Cannizzaro, Alyson Fiedler, Louis DeLucia, or Dan Swetnam or Ice Miller Litigation attorneys Adam Alexander, John Burke, Christina Fugate, or Eric Singer.

For additional guidance on COVID-19, visit our COVID-19 Resource Center.

This publication is intended for general informational purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstance.