October 26, 2010

Goody Goody: Third Circuit Affirms Stub Rent Can Be an Administrative Expense Claim

Holland & Knight Update
Barbra R. Parlin

Commercial lessors have long enjoyed certain individualized protections under section 365 of the Bankruptcy Code. The Third Circuit’s recent decision in In re Goody’s Family Clothing, Inc., __ F.3d ___, 2010 WL 2671929 (3d Cir. June 29, 2010), makes it clear that commercial lessors also can take advantage of the more general protections available to creditors to obtain payment for goods and services they provide to a debtor after it files for bankruptcy where the specific protections are not applicable.

Section 365(d)(3)

Section 365 of the Bankruptcy Code requires the debtor 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) of this title.” 11 U.S.C. § 365(d)(3). In other words, the debtor is required to pay all amounts that come due post-petition under a commercial real estate lease automatically, without any need for the landlord to first demonstrate that such amounts constitute “actual necessary costs and expenses of preserving the estate” as is required for the payment of an administrative claim under section 503(b)(1).

Notwithstanding this provision, there have been conflicting decisions regarding the application of section 365(d)(3), the provision that requires a debtor to pay all rent due post-petition, to “stub rent.” Stub rent usually refers to unpaid rent applicable to the period after a debtor files its case and before the first date when rent comes due post-petition.1 Some courts follow a proration rule, requiring a debtor to pay the pro-rated portion of any rent that falls due post-petition, even if the debtor filed in the middle of a month and the rent was due on the first of the month. See, e.g., In re Handy Andy Home Improvement Centers, Inc., 144 F.3d 1125, 1127 (7th Cir. 1998); In re Stone Barn Manhattan LLC, 398 B.R. 359, 362-366 (Bankr. S.D.N.Y. 2008). Courts that follow the proration approach likewise will construe section 365(d)(3) to require a debtor to pay only that portion of any real estate taxes billable post-petition that relate to the post-petition period. All other amounts, whether for taxes or pro-rated rent for the period before the petition date, are deemed a pre-petition claim.

Other courts follow a “billing date” approach. These courts construe section 365(d)(3) to require payment of any and all amounts that the applicable lease provides be billed post-petition, irrespective of whether such amounts apply in whole or in part to periods before or after the petition date or rejection date. See, e.g., Koenig Sporting Goods, Inc. v. Morse Road Co. (In re Koenig Sporting Goods, Inc.), 203 F.3d 986, 989 (6th Cir. 2000); In re R.H. Macy & Co., 152 B.R. 869, 872-73 (Bankr. S.D.N.Y. 1993), aff’d 1994 WL 482948 *13 (S.D.N.Y. Feb. 23, 1994). Under the billing date approach, section 365(d)(3) does not require a debtor to pay post-petition stub rent when the petition date falls after the date that the rent is due – those amounts simply become part of the lessor’s pre-petition claim. By contrast, a debtor is required to pay real estate taxes that are billable under the lease during the post-petition, pre-rejection time period, even if those taxes generally relate to the pre-petition period.

The Billing Date Approach and 503(b)(1) as Applied in the Third Circuit

The Third Circuit adopted the billing date approach in In re Montgomery Ward Holding Corp., 268 F.3d 205, 211-212 (3d Cir. 2001), finding that the plain language of section 365(d)(3) required the debtor to “timely perform all obligations” under the lease arising from and after the petition date until the lease is assumed or rejected. Accordingly, it held that the debtor was required to pay the full amount of real estate taxes billed pursuant to the lease post-petition, without proration.

Since then, courts within the Third Circuit generally have found that section 365(d)(3) does not require a debtor to pay stub rent. This is particularly important since Delaware, the venue of choice for many of the largest retail bankruptcy cases filed in recent years, falls within the Third Circuit.

Montgomery Ward didn’t end the discussion, however. Instead, landlords with claims against debtors with cases pending in the Third Circuit have sought to recover payment of stub rent pursuant to other provisions of the Bankruptcy Code, most often on the grounds that such rent is payable as an administrative expense under section 503(b)(1). Payment under this section is not automatic, as it is under section 365(b)(3). Rather, to obtain payment under section 503(b)(1), the landlord bears the “heavy burden of demonstrating that the stub rent for which they seek payment provided an actual benefit to the estate and that incurring stub rent was necessary to preserve the value of the estate assets.” Goody’s, 2010 WL 2671929, *4. In addition, some debtors argued that section 365(b)(3) preempted relief under section 503(b)(1), and thus stub rent could not be payable as an administrative expense. See, e.g., Goody’s at *2.

The Third Circuit ‘s recent decision in Goody’s confirms that section 503(b)(1) is another basis upon which a commercial landlord can seek payment of stub rent. In that case, the Court rejected the debtors’ attempt to limit commercial lessors to their remedies under section 365(d)(3), finding that nothing in that section preempts relief under section 503(b)(1). Id. at * 2-4.

That being said, payment of stub rent (or taxes) is not automatic. A landlord seeing a recovery under section 503(b)(1) must still satisfy the burden of demonstrating an actual and necessary benefit to the estate. This was satisfied in Goody’s because the debtors were using the stores to conduct going out of business sales during the period in question, the estate charged the liquidator it hired a per diem fee for occupation of the stores equal to the amount of rent during the relevant period and the estate reaped substantial revenue from the sales. Id. at *4-5. The Third Circuit explained:

Although mere occupancy is not always an actual and necessary expense that benefits an estate, there can be no reasonable dispute that the occupation of the leased premises here conferred a benefit ... . The sales required a physical venue, and remaining in existing premises was just as necessary and beneficial to the estate as leasing new premises specifically for store-closing sales. ... Thus, the Landlords are entitled to a reasonable “stub rent” as an actual and necessary expense for the benefit of the estate.

Id. at *5. The showing is not as simple under other circumstances. See, e.g., In re WCI Communities, Inc., 2010 WL 3523061 (Bankr. D. Del. Sept. 2, 2010) (denying lessor’s 503(b)(1) application for the payment of ad valorem taxes chargeable under the lease as additional rent, even though the debtor was occupying the leased premises, because the lessor failed to demonstrate that payment of the taxes would confer any benefit on the debtor’s estate); In re Sportsman’s Warehouse, Inc., 2009 WL 2382625 *6 (Bankr. D. Del. Aug. 3, 2009) (further hearing required to determine whether debtor’s occupation of leased premises during stub period was a benefit to the estate and if so, to determine the value of such benefit).

Even if a landlord satisfies its burden of demonstrating that occupation of the leased premises conferred an actual and necessary benefit on the debtor, there is no guarantee that the amount of rent due will be equal to the contract rate, or that the rent will be payable immediately. See, e.g., Sportsman’s Warehouse, 2009 WL 2382625 at *6 (the value of the benefit is presumed to be contract rate, but the debtor can submit evidence, including proof of actual market rent, that actual value is lower and refusing to order immediate payment); WCI, 2010 WL 3523061 at *4 (denying 503(b)(1) application for “additional rent” because no evidence that payment of ad valorem taxes due during the stub period benefitted the estate even when the debtor was occupying the space).


The commercial real estate market has been hard hit by the spate of retailer bankruptcy filings during the past two years, many of which were venued in Delaware. In at least some cases, it appears that the filing was timed to take advantage of the Third Circuit’s billing date rule and so avoid at least one month’s post-petition rent. The Third Circuit’s decision in Goody’s confirms that, notwithstanding the billing date approach, commercial lessors can obtain payment for stub rent even when the debtor files its case a day or two after the rent was due, if they can demonstrate an actual benefit to the estate.

For example, if a lease provides that rent is due in advance on the first of the month, and the debtor files its case on day two of the month without paying the rent, the rent due for the period of occupancy between the petition date and the first of the next month is the stub rent.

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