Restructuring

Contributed by David G. Litvack
For many debtors, section 365(a) of the Bankruptcy Code is a valuable tool that enables the shedding of over-market leases and unprofitable locations.  Section 365(a), however, is silent as to whether a bankruptcy court has the authority to approve a lease rejection retroactively.  If the rejection is effective prior to the date of entry of the order approving the lease rejection, the debtor is relieved of its obligation to pay rent as an administrative expense after the earlier, retroactive date.  Bankruptcy courts who have found the existence of this retroactive authority have struggled with when a retroactive lease rejection can be made effective.  In recent cases, debtors have proposed various dates for retroactive lease rejections to be effective, including the date objections are due to the rejection motion, the date the notice of the rejection motion is served upon the affected landlord, the date the rejection motion is filed, or even a date prior to the filing of the rejection motion.
In a recent decision, In re New Meatco Provisions, LLC, the United States Bankruptcy Court for the Central District of California found that in the Ninth Circuit the retroactive rejection of leases is not only permissible, but, under certain circumstances, rejection can be made retroactively to a date prior to the date of filing a motion seeking such rejection.
Prior to the commencement of its chapter 11 case on May 8, New Meatco Provisions, LLC leased certain commercial property.  On May 10, New Meatco surrendered its leased premises to the landlord in broom-clean condition.  Two weeks later, New Meatco filed a motion to, among other things, reject the lease retroactively to May 10, the day on which the debtor had surrendered the premises to the landlord.  The bankruptcy court subsequently entered an order approving the requested retroactive lease rejection.  After entry of the rejection order, the landlord filed a motion for reconsideration and asserted that, under Ninth Circuit precedent, a retroactive rejection to a date earlier than the motion filing date is prohibited as a matter of law.
The bankruptcy court began its analysis by reviewing the Ninth Circuit’s decision in In re At Home Corp.  In that case, the court held that, under section 105(a) of the Bankruptcy Code, a bankruptcy court may approve the retroactive rejection of a nonresidential lease when “necessary or appropriate to carry out the provisions of section 365(d)” of the Bankruptcy Code.  The Ninth Circuit identified four factors to be considered when determining whether “exceptional circumstances” warrant retroactive rejection:  (1) the debtor’s immediate filing of a motion to reject the lease; (2) the debtor’s prompt action in setting that motion for hearing; (3) the vacancy of the leased premises; and (4) the landlord’s conduct and motivation in opposing a retroactive rejection of the lease.  Relying on these factors, the Ninth Circuit approved the retroactive rejection of a lease to the date on which the rejection motion was filed.
The Meatco court found it significant that At Home and other decisions, including In re Jamesway Corp., did not expressly prohibit a bankruptcy court from exercising its equitable authority to approve a retroactive rejection date that is earlier than the rejection motion filing date.  The bankruptcy court, relying upon the Ninth Circuit’s decision in At Home, held that the “exceptional circumstances” necessary to order a retroactive lease rejection to May 10 – the date on which the rejection motion was filed – were present.  Notably, the bankruptcy court found it important that New Meatco sought the requested relief shortly after filing its chapter 11 case and also vacated the premises and surrendered the keys only two days after the filing.  Further, the Court reasoned that an allowed administrative expense for the period after May 10, 2013 would significantly harm New Meatco, its estate, and its creditors.
The bankruptcy court’s decision extends the At Home decision considerably given that At Home did not discuss retroactive rejection to a date prior to the rejection motion filing date.  Although the bankruptcy court found it significant that Meatco had turned over the keys and vacated the premises at issue by the date sought for rejection, in reality, this fact may be of little comfort to a landlord.  Absent court approval, a landlord is prohibited from terminating a lease and entering into a new lease for the vacant space leased by a debtor.  Typically, if a space is vacant and a lease is in effect, a landlord will receive full monthly payments in the ordinary course (or at least an administrative expense) until the debtor determines whether to assume or reject the lease.  After Meatco, however, a landlord’s assurance of receiving full payment for the period prior to the filing of a rejection or assumption motion may be called into question.
Although Meatco may be viewed as debtor-friendly, it is worth noting that only two weeks elapsed between the surrender of the premises and the filing of the rejection motion, and the debtor filed the rejection motion within a month after it filed its chapter 11 petition.  While the decision may be viewed as putting landlords on notice that once a debtor surrenders a leased property and turns over the keys, a retroactive rejection request might be forthcoming, it also may be limited by the particular facts regarding timing.  Of course, a diligent landlord will be faced with the question of whether it asks the bankruptcy court to compel the debtor that has surrendered premises to assume or reject the lease or whether it sits tight, challenges retroactive rejection, and then asserts an administrative expense for the pre-rejection period.