In a fine example of statutory construction taking sides on an issue where circuits are split, the Second Circuit concluded that the “billing approach” is the proper method for interpreting Section 365(d)(5).

When a chapter 11 debtor is subject to an unexpired lease for personal property, Circuit Judge Gerard E. Lynch held in his February 3 opinion that Section 365(d)(5) requires “the debtor to pay obligations once they come due under the operative lease, regardless of when the obligation can be said to have accrued.” The holding has the effect of expanding the right to a priority claim.

The same rule presumably applies to real property leases covered by Section 365(d)(3).

Given the split of circuits, the decision is a prime candidate for a certiorari petition.

Brokerage Fees for Aircraft Leases

The chapter 11 debtor was an airline that, of course, leased aircraft. Before bankruptcy, a broker had arranged for the airline to lease 20 aircraft. To avoid having the airline pay the brokerage fees in full when entering into the leases, the leases characterized the brokerage fees as “additional rental payments” to be paid in a schedule over the term of the leases. The leases referred to the “additional rental payments” as “unconditional obligations” of the airline.

Once in chapter 11, the airline did not assume the leases. As required by Section 365(d)(5), the airline began paying the aircraft lessors 60 days after filing. However, the airline did not pay “additional rent” to the broker.

Over time, the airline eventually rejected all of the aircraft leases.

Not having been paid, the broker filed proofs of claim and a motion under Section 365(d)(5) to compel payment as priority claims. In pertinent part, the subsection provides:

The trustee shall timely perform all of the obligations of the debtor, except those specified in section 365(b)(2), first arising from or after 60 days after the order for relief in a case under chapter 11 of this title under an unexpired lease of personal property . . . , until such lease is assumed or rejected . . . , unless the court, after notice and a hearing and based on the equities of the case, orders otherwise with respect to the obligations or timely performance thereof.

The airline objected to the motion to compel payment, contending that Section 365(d)(5) did not require payment as a priority claim because the broker performed no services after bankruptcy. Based on the “plain meaning” of the statute and “commercial realities,” Bankruptcy Judge David S. Jones of New York ruled in favor of the broker and compelled payment of about $4.3 million. He discerned that the additional rent came due on the dates specified in the leases. In re Avianca Holdings S.A., 20-11133, 2023 BL 26972, 2023 WL 494255 (Bankr. S.D.N.Y. Jan. 26, 2023).

The airline appealed, but District Judge Katherine Polk Failla affirmed. In re Avianca Holdings S.A., 23-1211, 2023 BL 472816, 2023 WL 9016495 (S.D.N.Y. Dec. 29, 2023). To read ABI’s report, click here.

District Judge Failla succinctly described Section 365(d)(3) as meaning that the debtor “must perform all of the debtor’s obligations under any unexpired lease of personal property arising after the expiration of the sixty-day grace period until that lease is assumed or rejected — unless the court orders otherwise.” Even more tersely, she said that “an obligation may be entitled to such priority if it ‘aris[es]’ after the bankruptcy filing.”

The airline appealed to the circuit.

The Circuit Split on Section 365(d)(5)

Judge Lynch characterized the appeal as presenting “a single question: did [the airline’s] obligation to pay the additional rental payments ‘first aris[e] from or after 60 days after the order for relief in a case under chapter 11 of this title’?” As a question of statutory interpretation, he undertook de novo review.

Judge Lynch wrote his opinion to be intelligible for readers who know nothing about bankruptcy. With regard to executory contracts and leases, he explained that “the debtor is generally not required to make a decision about its executory contracts immediately after filing for Chapter 11, or even within any set time frame before plan confirmation.” During the interregnum, he said, “creditors sit in limbo.”

Lessors of nonresidential real property and personal property, Judge Lynch said, “are granted enhanced protections during the waiting period following the initial bankruptcy filing.” He explained that “the debtor must resume making any contractually set payments that arise after a certain period of time during the bankruptcy before the relevant lease is assumed or rejected, regardless of whether the debtor is receiving a post-petition benefit.” [Emphasis added.]

Because the broker performed no services after filing, Judge Lynch said that the broker was not entitled to administrative claims under Section 503(b). The broker’s “sole path to a priority claim here is through Section 365(d)(5).”

For the broker to have priority claims, Judge Lynch said that the broker must “show that [the airline’s] obligation to pay the additional rental payments first arose at least 60 days after the petition date.”

Judge Lynch described “a deep, pre-existing split of authority regarding the proper method for determining when a debtor’s obligation arises.” On one side of the fence is the “accrual approach,” advocated by the airline, which “requires the debtor to pay only those obligations that accrued post-petition, irrespective of when those obligations come due under the operative lease.”

The accrual approach, Judge Lynch said, has been followed by several bankruptcy and district courts in New York, along with the Seventh Circuit and the Tenth Circuit Bankruptcy Appellate Panel.

Espoused by the broker, the “billing approach” is on the other side of the fence. Judge Lynch said it “requires the debtor to pay obligations once they come due under the operative lease, regardless of when the obligation can be said to have accrued.”

Judge Lynch cited the Third and Sixth Circuits plus the Eighth Circuit Bankruptcy Appellate Panel for adopting the billing approach, along with a decision by Justice Sonia Sotomayor when she was on the district court in New York.

Judge Lynch said that both approaches are “plausible” because “Section 365(d)(5) does not explicitly specify when an obligation can be said to have arisen.”

The Billing Approach

To decide which approach to adopt, Judge Lynch found the answer in “two contextual clues.” In the subsection, the words “timely perform” require “the existence of some presently existing duty that the debtor must fulfill.” The word “obligations” refers to an act for which someone is legally bound.

From dictionaries, Judge Lynch said that the statutory language — “first arising from or after 60 days after the order for relief” — “is best understood as specifying that the duty the debtor must perform has to ‘originate from’ or ‘come into being’ under an unexpired lease of personal property 60 days after the order for relief or later.”

“That is the ‘billing date’ approach,” Judge Lynch said.

Judge Lynch said there is a “critical difference between when a creditor’s claim arises and when a debtor’s obligation arises, while [the airline’s] position conflates them.” Furthermore, he said that the airline’s “approach would reimpose Section 503(b)(1)’s requirement that there be a post-petition benefit to the estate.” He emphasized “that Section 365(d)(5) speaks in terms of the debtor’s obligations, not the creditor’s claims.” [Emphasis in original.]

Judge Lynch noted how Section 365(d)(5) has different requirements for priority treatment than Section 503(b), because “365(d)(5) explicitly requires priority payment of the debtor’s obligations first arising 60 days post-petition ‘notwithstanding section 503(b)(1) of this title.’” [Emphasis in original.] He added that Section 365(d)(5) “refocuses the relevant inquiry on whether the debtor has a performance obligation, instead of on whether the debtor receives a post-petition benefit.”

Judge Lynch said that his reading “aligns with sound bankruptcy policy,” as shown in the 1994 House Report, which he characterized as saying that the amendment “tip[s] the balance slightly in favor of creditor protection.” In other words, “Section 365(d)(5) is best understood as a specific intervention that grants creditors under unexpired leases of personal property priority treatment, over other general unsecured creditors.”

Judge Lynch ended his opinion by saying that the airline did not avail itself of “two safety valves.” First, the debtor had a 60-day grace period when payments were not required. Second, the debtor could have petitioned “the bankruptcy court for a hearing to amend its payment obligations after the 60-day grace period elapses.” The debtor, he said, “chose not to use either of the safety valves that Congress built into Section 365(d)(5).”

Judge Lynch affirmed the judgment of the district court.