How a Landlord's Administrative Claim for Stub Rent Could Be Curtailed under § 503(b)

The majority of real property leases provide for prepayment of rent on the first of each month.[1] However, tenants filing for chapter 11 do not always pay on the day their rent is due and payable. This creates situations where tenants will fail to pay rent when it is due, subsequently file for bankruptcy and then occupy the premises after the petition date. While these debtors may use and occupy the premises after filing for bankruptcy, landlords are not necessarily without a remedy to collect money for that period. Landlords will seek payment of “stub rent,” which is “the rent for the period from the petition date through the first of the following month.”[2] Courts use two different approaches to determine whether a landlord has an administrative claim for stub rent. Some courts hold that an administrative claim for stub rent is allowed under § 365(d)(3),[3] while others hold that an administrative claim for stub rent is allowed under
§ 503(b).[4] Recently, in In re Sportsman’s Warehouse Inc., the Bankruptcy Court for the District of Delaware adopted the second approach.[5] However, it held that while an administrative claim for unpaid rent is permitted under § 503(b) as an actual and necessary expense of preserving the estate, the landlord is only entitled to an administrative claim in the amount of the benefit to the estate.[6] The court explained that because chapter 11 proceedings are designed to assist the debtor in rehabilitating its business, the debtor should only be required to pay an amount equal to the benefit received by occupying the premises post-petition, which may or may not equal the amount specified in the lease.[7]

This article focuses on whether a landlord who seeks payment of an administrative claim for stub rent is per se entitled to an administrative priority for the entire amount due under the lease. The first part discusses why certain courts have held that an administrative claim for stub rent may be allowed under § 503(b) but not under § 365(d)(3). The second part details the court’s holding in In re Sportsman’s Warehouse, including the court’s unambiguous reversal of its earlier position, as well as the policy considerations underlying the court’s reasoning, as well as  how courts determine the amount of the benefit to the estate, and why this may impact a landlord’s administrative claim for stub rent. The third part focuses on why Sportsman’s Warehouse is consistent with the purposes of the Bankruptcy Code. This article concludes with a discussion of the impact that Sportsman’s Warehouse may have on a landlord’s ability to collect stub rent, especially in today’s economy.

An Administrative Claim for Stub Rent under § 503(b)
After a chapter 11 debtor has occupied the premises during the stub rent period, the landlord may “file a request” for payment of administrative expenses.[8] The importance of acquiring an administrative claim for stub rent is that the landlord will “receive first priority” in the payments made by the debtor.[9] However, in order to have a valid administrative claim for stub rent, a landlord must first bring a motion under the appropriate section of the Code. There are two sections that a landlord may utilize. Section 365(d)(3) provides that “the trustee shall timely perform all the obligations of the debtor…arising from and after the order for relief,”[10] and § 503(b) provides that “there shall be an allowed administrative expense” for the “actual, necessary costs and expenses of preserving the estate.”[11] Several courts, including the Bankruptcy Court for the District of Delaware, have held that an administrative claim for stub rent is appropriate under § 503(b) but not § 365(d)(3).[12]

Since leases generally require payment of rent on the first of the month, § 365(d)(3) is not the appropriate avenue through which a landlord should seek an administrative claim for stub rent. This Code section provides that the trustee must “timely perform all the obligations of the debtor” arising after the petition date (“post-petition”). In the context of § 365(d)(3), an “obligation” is “something that one is legally required to perform under the terms of the lease.”[13] Moreover, an obligation is created when the debtor becomes “legally obligated to perform it.”[14] When landlords move for an administrative claim for stub rent, they are seeking payment of money that the debtor was legally obligated to pay on the first of the month prior to filing for bankruptcy. Therefore, a debtor’s obligation to pay the month’s rent arose pre-petition and, thus, § 365(d)(3) does not authorize an administrative claim for stub rent.[15] However, this does not preclude landlords from pursuing an alternative avenue for payment of administrative claims for stub rent.[16]

An administrative claim for stub rent may be allowed under § 503(b),[17] which provides, in pertinent parts, that “there shall be allowed administrative expenses” for “the actual, necessary costs and expenses of preserving the estate.”[18] Since a chapter 11 debtor generally remains in the leased premises to commence the reorganization process, many courts recognize that the payment of rent for the continued use and occupancy of the leased premises customarily qualifies as an “actual, necessary” expense of preserving the estate.[19] In Zagata Fabricators Inc. v. Superior Air Products, for example, the Third Circuit Court of Appeals stated that “rent is clearly an ‘actual, necessary’ cost of preserving the estate, since the debtor’s survival depends on its ability to pay the landlord for the right” to use and occupy the premises.[20] Similarly, in In re Goody’s Family Clothing, the Bankruptcy Court for the District of Delaware relied on Zagata Fabricators in explaining that “the mere fact that the Debtors are occupying” the premises was sufficient to establish that the stub rent was an actual, necessary expense of preserving the estate.[21] The court then held that the landlords were entitled to seek an administrative claim for stub rent under § 503(b) because the continued use and occupancy of the leased premises provided a benefit to the estate.

Specifically, in Goody’s Family Clothing, the court held that the amount of the administrative claim for stub rent was the fair-market value of occupancy.[22] The court also held that this amount was “presumed” to be the amount specified in the lease.[23] In Goody’s Family Clothing, the fair-market value of occupancy was not in dispute and the court granted the landlord’s claim in an amount equal to the lease rate. However, the court added that use and occupancy per se provides a benefit to the estate in the amount of the fair-market value of the occupancy.[24] Less than one year later, though, the Bankruptcy Court for the District of Delaware held in Sportsman’s Warehouse that this approach was “a misapplication of the law,” and set forth a new analysis to determine the amount that landlords are entitled to receive as an administrative claim for stub rent under § 503(b).[25]

The New Approach to Stub Rent under § 503(b)
Within the first two paragraphs of Sportsman’s Warehouse, the court made two points explicitly clear. First, even though an administrative claim for stub rent is not allowed under
§ 365(d)(3), landlords may have an allowed administrative claim under § 503(b) for the debtor’s use and occupancy of the premises during the stub rent period. Second, the court’s holding in Goody’s Family Clothing was “inappropriate” and should no longer be followed.[26] Specifically, the court stated:

While Zagata Fabricators provides that rent is an actual and necessary expense, it was inappropriate for this Court to apply a per se rule in Goody’s Family Clothing that the use and occupancy of the premises confers a benefit to the estate. Rather, the Court must analyze the evidence submitted and determine, on a case-by-case basis, the amount of the benefit to the estate.[27]

Sportsman’s Warehouse, a retail sporting goods store, filed for chapter 11 on March 21, 2009, and at this time, was renting the warehouse in which it operated its business. Despite the fact that rent was due and payable on the first of each month, Sportsman Warehouse failed to pay the rent due on March 1, 2009. Consequently, the landlord sought payment of the unpaid stub rent for the period from March 21, 2009, through March 31, 2009. The court explained that while Goody’s Family Clothing held that a debtor’s post-petition use and occupancy of leased premises per se creates an administrative claim, that holding was a “misapplication of the law and will no longer be followed by this Court.”[28] The court held that a case-by-case analysis “must” be used to determine the amount of benefit to the estate, the result of which will provide the amount of payment to which the landlord is entitled as an administrative claim under § 503(b).

The court made clear that, because bankruptcy proceedings are “equitable,” the landlord’s ability to collect stub rent “is somewhat curtailed.”[29] The court acknowledged that a debtor’s post-petition use and occupancy of leased premises is an actual and necessary expense of preserving the estate. However, since chapter 11 proceedings are designed to assist a debtor in rehabilitating its business, a debtor should only be required to pay a reasonable value for the use and occupancy of the property.[30] The court stated that a reasonable value is an amount equal to the benefit the debtor received by occupying the premises, which “may or may not” equal the lease rate. In fact, the use and occupancy may provide “little or no benefit to the estate.”[31]

This approach does not automatically preclude a landlord from acquiring an administrative claim for stub rent that is equal to the amount specified in the lease. Rather, it merely provides that a court must determine the amount of the benefit to the estate on a case-by-case basis. Under this approach, the amount of the benefit is presumed to be the bargained-for rate of rent as found in the lease.[32] Nevertheless, the debtor is entitled to rebut that presumption.

The debtor was permitted to submit evidence to establish that the benefit to the estate is less than the amount specified in the lease. The evidence “may include, but is not limited to, proof of the [current] fair-market value of rent.”[33] Therefore, even if the lease rate was consistent with the fair-market value of rent at the time the lease was executed, the debtor will not be required to pay that amount in stub rent if it is established that the current fair-market value of rent is less than the lease rate.[34] Additionally, the debtor may submit evidence to demonstrate that even though it continued to occupy the premises, it ceased its operations and only used the premises to store its products and machinery.[35] After the debtor submits evidence to rebut the presumption, the court will analyze the facts on a case-by-case basis. For example, in Sportsman’s Warehouse, the debtors submitted evidence that the property’s fair-market value was less than the amount specified in the lease. The bankruptcy court held that an evidentiary hearing was necessary to determine “what benefit, if any,” the debtor received from the post-petition use and occupancy of the landlord’s property.[36] The results of that hearing have not been released.

How the New Approach Furthers the Purposes of the Code
The underlying policy reasons for the court’s holding in Sportsman Warehouse are consistent with the purposes of the Bankruptcy Code. First, through use of a case-by-case analysis rather than a per se rule, courts can provide chapter 11 debtors with a better chance to successfully reorganize.[37] Reorganization under chapter 11 is designed to permit the successful rehabilitation of debtors. Successful rehabilitation is advanced through one of the Code’s main purposes: providing a debtor with a “fresh start” subsequent to filing for bankruptcy.[38] Therefore, permitting a debtor to dispute whether its use and occupancy of the leased premises provide a benefit to the estate that is below the lease rate provides a debtor with the most auspicious opportunity to successfully reorganize because it enables a debtor to maximize the value of the estate. An important component of a successful reorganization is the ability to spend and invest money “wisely.”[39] This aspect is enhanced when the debtor is able to prove that the benefit to the estate is below the lease rate because that will provide more money to use in the reorganization process.

On the other hand, mandating that landlords be entitled to the lease rate of rent is inconsistent with the rehabilitative purposes of the Code and the “fresh start” policy of bankruptcy law. Failing to use a case-by-case analysis to determine the amount of the benefit to the estate may require debtors—the individuals who are supposedly starting anew—to owe an amount that exceeds the actual amount of the benefit to the estate.[40] Such a mandate would diminish the “fresh start” policy of bankruptcy and effectively force debtors to start in the hole, rather than starting anew.[41]

Second, permitting a debtor to dispute whether its post-petition use and occupancy of the premises provided a benefit that was less than the lease rate of rent is consistent with the notion that bankruptcy proceedings are equitable.[42] As the Third Circuit Court of Appeals stated in Zagata Fabricators, “[b]ecause bankruptcy proceedings are considered to be equitable, the landlord’s right to collect monetary relief is somewhat curtailed.”[43] After quoting this precise language, the Bankruptcy Court for the District of Delaware, in Sportsman’s Warehouse, held that a case-by-case analysis must be used and that debtors may attempt to rebut the presumption that the amount of the benefit to the estate equals the lease rate. The equitable nature of bankruptcy proceedings places the focus of the analysis on the actual benefit to the estate, not the loss incurred by the landlord.[44]

Conclusion
Although the approach used by the Sportsman’s Warehouse court furthers the purposes of the Code, it may curtail a landlord’s administrative claim for stub rent more than the court anticipated. Under this approach, debtors may submit evidence of the current fair-market value of rent to prove that the amount of the benefit to the estate was less than the bargained-for amount specified in the lease. Given the current economic conditions and the downward trend of the real estate market, this means that a landlord’s claim for stub rent may be greatly curtailed. While the onus may be on the debtor to rebut the presumption that the benefit to the estate equals the amount specified in the lease, this decision demonstrates that, for at least one court, a landlord is no longer guaranteed an administrative claim for stub rent that equals the amount specified in the lease.