Contributed by Victoria Vron
The United States Bankruptcy Court for the Middle District of Tennessee, in its recent decision in In re Oreck Corp., has added another notch in the “billing date approach” column in the national debate over whether stub rent is payable pursuant to section 365(d)(3) of the Bankruptcy Code. Stub rent, which is the amount due to a landlord for the period of use and occupancy between the petition date and the first postpetition rent payment date, is an expenditure that affects virtually every debtor and for certain debtors, such as retailers, may significantly affect the debtors’ cash requirements early in the case (depending on whether a particular jurisdiction uses the billing date approach or its alternative, the proration approach, to determining whether stub rent is payable).
In Oreck, the debtor filed a chapter 11 petition on May 6, 2013. The lease for its headquarters provided that rent was due and payable in advance on the first of each month. The debtor failed to pay the rent for May 2013, which was due and payable on May 1, 2013. The debtor continued to occupy some or all of the headquarters postpetition, but only paid rent that became due and payable after May 1, 2013. The landlord filed a motion to seek allowance of the stub rent portion of the rent (the rent from May 6, 2013 through May 31, 2013) as an administrative expense under section 365(d)(3) and/or section 503(b)(1)(A) of the Bankruptcy Code. The bankruptcy court denied the request holding that the stub rent did not qualify as an administrative expense under either section of the Bankruptcy Code.
Section 365(d)(3) of the Bankruptcy Code provides, in relevant part, that:
[t]he trustee shall 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.
Section 365(d)(3) is a somewhat controversial provision that requires debtor-tenants to timely pay rent postpetition under a nonresidential real property lease prior to rejection, regardless of whether the debtor is actually using the leased property. Accordingly, debtors often contest whether a particular obligation falls within the section 365(d)(3) requirement. Stub rent is one of the often contested obligations.
Courts have adopted two different approaches to determining whether stub rent is an obligation that arises “from and after” the petition date, such that it would fall within section 365(d)(3). Some courts (e.g., those in the Third and Eighth Circuits) have adopted the “billing date” approach, which looks at the date rent becomes due and payable under the lease. If the date is prior to the petition date, then the stub rent is a prepetition, unsecured claim and is not an obligation that arises “from and after” the petition date. Other courts (e.g., courts in the Second, Fourth and Ninth Circuits) have adopted the “proration” approach (also sometimes referred to as the “accrual” approach), which (as its name implies) prorates the rent for the month straddling the petition date into the prepetition and postpetition portions, and requires that the postpetition portion of that month’s rent be paid “timely” pursuant to section 365(d)(3).
The bankruptcy court in Oreck sided with those courts that have adopted the billing date approach. It relied heavily on the decision of the United States Court of Appeals for the Sixth Circuit in Koenig Sporting Goods, in which the Sixth Circuit adopted the billing date approach to determining whether the rent payable in the month during which the lease was rejected was payable in full under section 365(d)(3). In Koenig, the Sixth Circuit held that a debtor had to pay rent for the entire month because rent was due and payable under the lease on the first of the month, even though the debtor rejected the lease on the second of the month. The Sixth Circuit found that the language of section 365(d)(3) was unambiguous as to the debtor’s rent obligation and rejected the debtor’s argument that equity and common sense compelled adoption of the proration method in that context. The landlord in Oreck unsuccessfully tried to distinguish Koenig arguing that the result in Koenig should be limited to the end of the section 365(d)(3) period because a debtor can control the timing of rejection (and therefore presumably try to avoid the harsh result that occurred in Koenig). The bankruptcy court, however, could not get past the Sixth Circuit’s finding that the language of section 365(d)(3) – that the rent obligation arises when rent becomes contractually due under the lease – is unambiguous.
Accordingly, because the May rent in Oreck was due prepetition, the bankruptcy court held that the stub rent did not fall within the scope of section 365(d)(3).
Section 503(b)(1) of the Bankruptcy Code provides, in relevant part, that a court may allow as administrative expenses “the actual, necessary costs and expenses of preserving the estate.” Like the landlord in Oreck, landlords often seek payment of stub rent under this section if their efforts to collect stub rent under section 365(d)(3) fail. Section 503(b)(1) is not as advantageous to landlords as section 365(d)(3) because it requires that the rent be an actual and necessary cost and expense of preserving the estate (thus if a debtor is not using the real property, this test is unlikely to be satisfied) and there is no requirement for timely payment of rent (in fact, some debtors delay paying administrative expenses until later in the case). But even the ability to seek administrative expense priority for stub rent under section 503(b)(1) is controversial. As the Oreck court pointed out, there is a disagreement among the courts as to whether section 503(b)(1) can apply to stub rent when section 365(d)(3) does not. Although the Oreck court claimed that it was not weighing in on this debate, its holding effectively precludes a landlord from ever receiving payment of stub rent pursuant to section 503(b)(1) if section 365(d)(3) does not apply. In reaching its decision, the Oreck court relied heavily on another Sixth Circuit decision, Baby N’ Kids Bedroom, in which the Sixth Circuit held that stub rent was not entitled to administrative expense priority under section 503(b)(1) because it became payable prepetition. The Sixth Circuit explained that an administrative expense under section 503(b)(1) has two defining characteristics: (i) the expense and right to payment arise after the filing for bankruptcy, and (ii) the consideration supporting the right to payment provides some benefit to the estate. Whether the right to payment occurs prepetition or postpetition focuses on when the acts giving rise to a liability took place, not when they accrued. According to the Sixth Circuit, the right to payment of rent arises when the rent is due and payable under lease.
Given the Sixth Circuit’s decision in Baby N’ Kids, the Oreck court held that the stub rent was a prepetition claim because the debtor’s obligation to pay the May 2013 rent arose prepetition. Whether or not the debtor actually used the headquarters postpetition was irrelevant.
Although the landlord lost on both of his arguments, the bankruptcy court found that the outcome in Oreck was not offensive. According to the court, one of the goals of section 365(d)(3) was to relieve landlords of some of the uncertainties of collecting rent during the prerejection period in a bankruptcy case – the unambiguous reading of section 365(d)(3) adopted by Koenig and applied to section 503(b)(1) in Baby N’ Kids produces certainty with respect to stub rent.
Unfortunately for those who like consistency, not all courts share the Oreck court’s view that sections 365(d)(3) and 503(b)(1) are unambiguous such that the billing date approach to stub rent should govern. A legislative or Supreme Court-level solution is needed to select just one approach that will apply in all jurisdictions. The uncertainty as to which approach a particular court will use in determining whether stub rent is payable is harmful to both landlords and debtor-tenants – it hinders prepetition planning, encourages forum shopping, and leads to higher litigation costs.