Litigating the Nonpayment of Rent Due to the Coronavirus

As state and local governments begin to reinstate or expand restrictions on the operation of retail establishments and restaurants to curb the spread of the novel coronavirus, operators of such establishments and their lessors must again focus on who must shoulder the economic impact of that burden. In this author’s experience, disputes over the payment of rent most commonly are resolved through rent abatements or deferrals — after all, it is not as though there are many replacement tenants in the market who are not confronting the same issues as existing tenants, and market rents appear to be down nationwide. But sometimes a negotiated resolution is not in the cards, so the parties need to look to litigation. This article examines two common issues that arise in such litigation: the impact of force majeure provisions in the lease documents, and the discretion of bankruptcy courts to order the deferment of rent payments.

Three Code provisions are particularly salient in drawing the battle lines. First, § 365(d)(3) requires the trustee or debtor-in-possession to perform most obligations of the debtor until an unexpired lease is assumed or rejected, provided that the court may extend for cause the time for performance of obligations arising within 60 days of the entry of the order for relief. Second, § 365(b) requires the cure of most existing defaults before an unexpired lease may be assumed. Third, § 365(d)(2) permits a lease party to seek an order requiring the trustee or debtor-in-possession to determine within a specified period whether to assume or reject an unexpired lease. Together, these provisions grant a tenant-debtor some leeway in performance, but grant its lessor the right to require performance or, coupled with § 362, secure relief from stay or adequate assurance.

The initial question one must consider — from the debtor’s side and the lessor’s side — is whether rent is due at all right now. Most leases include force majeure provisions that suspend or excuse a party’s obligation to perform during the continuation of certain events. While these provisions typically guard against disruptive events like fire, it is fairly common for them to also address government acts that impair a party’s ability to perform. The specific lease language and applicable state law will be key to determining whether an event of force majeure has occurred, and if so, what that means for the party who suffered it. Some points to consider are:

• Does the plain language of the force majeure clause apply? This is particularly important because generally, economic hardship or adverse market conditions alone are not enough to trigger force majeure. Also, in some states a force majeure clause will displace doctrines of impossibility or commercial frustration, while in others a force majeure clause will be considered to supplement those doctrines. Thus, in some states force majeure clauses will be read narrowly and will be deemed to exclude any events not specifically identified.
• Have the appropriate notices been given to trigger application of the force majeure clause?
• Under the terms of the lease and applicable state law, does force majeure apply to reduced ability to perform or only to complete inability to perform? In some states, it may even be possible to argue that a debtor that still has the ability to pay still has the ability to perform, even if its ability to generate revenue has been impacted by an event of force majeure.
• Under the terms of the lease and applicable state law, must a party show that the event was unforeseen or unforeseeable, or that they were unable to take reasonable steps to protect against either the event or its adverse effects?
• What is the effect of an event of force majeure? Under some contracts, it serves to excuse performance, while in others it serves only to defer performance.

Counsel is cautioned that under the laws of most states — if not all of them — force majeure is an affirmative defense for which the party invoking the doctrine bears the burden of proof. Counsel also should consider that even if force majeure applies, it may not be a complete defense. [1] If force majeure applies, it may eliminate the debtor-tenant’s obligation to pay rent in its entirety, or it may defer that obligation. If force majeure does not apply, there remains the question of whether and when a debtor may be obligated to pay under § 365(d)(3).

As noted, § 365(d)(3) permits the deferral of obligations that arise “within 60 days after the date of the order for relief, but the time for performance shall not be extended beyond such 60-day period.” Bankruptcy courts have readily accepted coronavirus restrictions as “cause” to defer performance under § 365(d)(3), as documented and discussed by Paul J. Ricotta and Katilin R. Walsh in their article “Mothballing Motions from Retail Debtors to Avoid Rent Payments Due to COVID-19 Pandemic.” [2]

Counsel should be careful not to assume too much about the rights and obligations under § 365(d)(3), because there is a deep divide on how § 365(d)(3) is applied in practice. In In re Pier 1 Imports Inc., for instance, the court found that § 365(d)(3) does not give a lessor the right to compel payment, but rather entitles the lessor to administrative expense claims that must be paid in full on the effective date of a confirmed plan. [3] However, lessor’s counsel should be mindful that a delay in payment is virtually inevitable, and the question at that point becomes whether the lessor prefers to seek to establish a deadline for assumption or rejection and roll the dice that its lease will be assumed (or, alternatively, that it will be rejected and the lessor can quickly find a new tenant at a sufficient rent rate). Lessors may also seek adequate protection under §§ 361 and 362, but, as shown by Pier 1, such efforts might not be successful absent an evidentiary showing that the deferment of rent payments impairs the value of the lessor’s property.

As with most matters impacted by the coronavirus, a debtor’s nonpayment of rent is not a simple one to address. Current market realities mean that it is rarely prudent, either for the lessor or the tenant, to litigate nonpayment of rent rather than reach an agreement. But when an agreement is not in the cards, it is time to pay close attention to the lease’s force majeure provision and the terms of § 365(d).