COVID-19’s Impact on Lease Restructurings: A Look Back and a Look Forward

With the mandatory government shutdown orders, surges in unemployment affecting rental demand, prices declining and companies driven to shift their workforce to remote work, 2020 has certainly left a mark on commercial leases. The general feeling of uncertainty as we head into the New Year in the midst of COVID-19’s economic disruption is surely going to continue impacting bankruptcy retail cases.

Throughout the year, we have seen the affected parties modifying lease terms, reducing rental fees, entering into forbearance agreements and deferments, extending maturity dates, allowing rent-forgiveness for the governmental shutdown period or simply terminating leases in their efforts to avoid bankruptcy or total insolvency. Some landlord/tenant parties have opted to apply all or part of the security deposit or the letter of credit to the unpaid rent as reasonable consideration for termination. Other tenants, not able to continue with their present economic struggles, have opted instead to reorganize in bankruptcy.[1]

In an attempt to excuse payment of rent, 2020 brought a streak of modifications to commercial lease contracts in an effort to relieve the parties from performing their obligations by enforcing force majeure clauses. Tenants with leases that do not include force majeure clauses, or specifically address pandemics and excuse or delay the tenant’s obligation to pay any rent or other obligations due to a pandemic, addressed the issue under common law, arguing that COVID-19 rendered performance impracticable, illegal, inadvisable or impossible.[2]

Likewise, we saw federal courts construing force majeure clauses to be either inapplicable where it did not consider governmental or custom interference as a force majeure event,[3] or conversely, interpreting the clause as applicable, as seen in In re Hitz Restaurant Group,[4] where the bankruptcy court analyzed the contract to hold that the impact of the government shutdown order caused by the pandemic excused performance, at least for the period of time the restaurant had to suspend its on-premises dining. Thus, with the filing of a bankruptcy petition, the bankruptcy courts have been confronted with the challenge of applying the language of the contract and the Code to fit the reality of the times.

Generally, a lease of real property that has not been terminated prior to the filing of a bankruptcy petition is an executory contract under 11 U.S.C. § 365, et seq., enforced according to its terms under state law.[5] Once a tenant files for bankruptcy, the benefit of the automatic stay is triggered, granting the tenant a freeze in its status quo while considering whether it intends to assume or reject the lease contract.[6] A tenant debtor who has defaulted and intends to retain and assume the commercial lease must provide for (1) cure of the unpaid rent, inclusive of common-area maintenance fees, real estate taxes and late fees, and attorney fees if authorized under the lease;[7] (2) adequate assurance; and (3) adequate assurance of future performance of the lease terms.[8]

If the tenant decides to reject an unexpired commercial lease, the landlord is left with an unsecured general claim and, perhaps, the security deposit or letter of credit, if one was given. In addition, the landlords claim, if it is a shopping center, it is capped under § 502(b)(6) to unpaid rent “the greater of one year lease or 15%, not to exceed 3 years” of the remainder of the lease term.[9] Lastly, where the tenant decides to assume but subsequently rejects the lease contract, a portion of the claim may be elevated to an administrative expense pursuant to § 503(b)(1).

All obligations of the chapter 11 debtor that have arisen under such leases until they are assumed or rejected must be timely (emphasis added) performed after the filing of the order for relief to the time of assumption or rejection of the lease by the strict language of 11 U.S.C. § 365(d)(3).[10] The statutory duty to “timely” perform is explicit and unequivocal. The Code limits the time for performance not to be extended beyond the 210-day deadline, after which a lease of nonresidential real property is deemed rejected.[11]

Deference to the rule of law while granting postponement of contractual obligations or granting temporary suspension of the bankruptcy case has been made possible pursuant to 11 U.S.C. § 305. This section, which permits the court to suspend all proceedings therein if it is in the best interests of creditors and debtor, is subject to the bankruptcy court’s discretion.[12] Suspension is generally considered to be an extraordinary proceeding, to be used sparingly where the interests of creditors and the debtor would be better served by such dismissal or suspension, and made on a case-by-case basis.[13] Consequently, the court will consider all factors involved, as opposed to rendering its decision under a predefined legal rule, and for the most part it appears to have successfully allowed the continuance of a business relationship in a market of rescission.

Delaying payment has also been possible under the court’s equitable powers pursuant to 11 U.S.C. § 105. This section allows the court to use its equitable powers as long as “necessary or appropriate” to carry out provisions of the Bankruptcy Code.[14] This section is also discretionary.

Yet, assisting the tenant in retaining the lease after filing for bankruptcy by suspending the bankruptcy proceedings beyond what is considered timely under § 365(d)(3) may be seen as an abuse of discretion where the statutory time scheme created is clear. “Timely” payment must not exceed the statutory bar date of 210 days. Moreover, there are obligations other than rent payments that may be in need of immediate action. Thus, the court, as an instrument of law, may not have the discretion to delay. As courts continue to review the lease under § 365(d)(3) and attempt to foster the “fresh start” policy of the Code, the bankruptcy court may find ways to assist the tenant in this pandemic with rulings similar to In re Hitz, supra

The pandemic does not seem to be going away anytime soon, even with various vaccines insight. Management of cash flow and projections, and a review of the debt-leverage and business models, may reveal that some parties will be better off seeking bankruptcy protection. Seemingly, where the lease is modified through out-of-court workouts, the affected parties might end up in a better position, even when the tenant later on succeeds in using chapter 11 as a shield against the pandemic economic wrap, as the tenant is able to propose a reorganization under already modified terms.

For debtor’s counsel figuring out what is best for the debtor but also works best for all stakeholders and constituents in the year to come may involve mediation of the lease terms, modification of rent through less space, or allowing a hybrid use of the space. In a bankruptcy consensual forum, assumptions, subleases or assignments under § 365(f) may be seen in the year ahead. The future of commercial leases remains uncertain in the year ahead. The only certainty lies in our own emotional affirmation of “better things ahead than any we leave behind.”[15]