“Can an unsecured creditor be better off when the debtor defaults rather than paying off the debt? Yes: Law can be stranger than fiction in the Preference Zone.”—Ninth Circuit
This is the eighth in a series of alerts on insolvency topics affecting real estate. In this alert, we discuss the portion of the recent Chuck E. Cheese decision denying the debtor’s/tenant’s request to defer paying rent after the 60-day “rent holiday” period prescribed in section 365(d)(3) of the Bankruptcy Code.
Chuck E. Cheese restaurants, operated by CEC Entertainment Inc. (CEC), are primarily a pizza and arcade-fueled birthday party venue for young children. Public health measures implemented by state and local authorities in response to COVID-19 shuttered arcades, and otherwise limited or prohibited large indoor gatherings to dine and socialize. The ability to play games is so inextricably tied to the Chuck E. Cheese experience that CEC’s senior management decided to close many locations, reasoning that the business model would be damaged by allowing children to dine with games that could not be played lurking in the background. This ultimately led to CEC’s “free-fall” chapter 11 bankruptcy filing in June 2020.
With little to no revenue at many locations, CEC and other retail debtors have found it hard during COVID-19 to comply with Bankruptcy Code section 365(d)(3)’s requirement that a commercial debtor tenant timely perform all of its lease obligations pending the assumption or rejection of the lease. That provision also allows such debtors to request, for cause, a 60-day “rent holiday” after the bankruptcy filing date before requiring them to commence paying post-petition rent, and courts have had little trouble in finding that the COVID-19 pandemic constitutes cause warranting a 60-day rent deferral. However, given the pandemic’s lasting impact, and related governmental orders that have negatively affected operations, revenues and the ability to pay rent, some retail debtors have considered legal strategies for obtaining, over the objections of landlords, more than 60 days of rent relief.
Rent Deferral under Bankruptcy Code section 365(d)(3)
Before COVID-19, bankruptcy courts rarely granted a 60-day extension under section 365(d)(3). In one of the few cases where that relief was granted, the bankruptcy court noted that “attempts at negotiating [a] settlement constitute ‘cause’ for extending the time for performance an additional sixty (60) days.” In re DWE Screw Prods., Inc., 157 B.R. 326, 329 (Bankr. N.D. Ohio 1993). But even before, and after, DWE, requests for a 60-day extension were generally denied. See, e.g., In re T-Rex Partners, LLC, 2008 Bankr. LEXIS 5162, *10-12 (Bankr. D. Nev. 2008) (denying request for 60-day extension for lack of cause based on (i) mere presence of a second ground lease or lessor’s legal disability to conduct business or (ii) debtor’s immediate need to obtain insurance coverage after insurance lapses); In re Pac-West Telecomm, Inc., 377 B.R. 119, 126 (Bankr. D. Del. 2007) (bankruptcy filing does not constitute “cause” under section 365(d)(3); rather, “specific cause” or “applicable legal precedent” is required to obtain relief under section 365(d)(3)); In re S & F Concession, Inc., 55 B.R. 689, 691 (Bankr. E.D. Pa. 1985) (acknowledging that debtor was previously denied a 60-day extension).
Since COVID-19, however, debtors have sought and easily obtained 60-day extensions.1 An additional strategy pushed by some debtor tenants was to reserve the right to seek additional rent holiday extensions, beyond the 60-day provided by section 365(d)(3).2 In Pier1 Imports, the debtor did more than reserve the right to request an additional rent holiday, it affirmatively asked the bankruptcy court to defer rent payments beyond the first 60 days. Over several landlords’ objections, the court granted that request to defer rent payments by an additional 30 days.
The CEC Court Denies the Debtors’ Rent Holiday Motion
Days after its bankruptcy filing, CEC sought and obtained, over the objection of many landlords, an initial 60-day rent holiday. Months later, CEC filed a second motion in which it sought to further delay or abate rent due to the coronavirus pandemic and related governmental restrictions until the restrictions were lifted. This motion initially sought to excuse CEC’s obligation to pay rent at 141 locations across 12 states and was opposed by several of the debtor’s landlords. Undoubtedly fearing that the debtor would prevail, and “bad law” would be created giving retail debtors a super rent holiday (i.e., beyond the statutorily prescribed 60 days), many of the landlord objections were resolved. Yet, several landlords continued their objection to the super rent holiday and were ultimately vindicated.
In its second rent abatement motion, CEC urged the bankruptcy court to exercise its equitable powers under section 105(a) to excuse its rent obligations beyond the initial 60 days of the case. Section 105 of the Bankruptcy Code authorizes a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code. CEC argued that this broad equitable grant authorizes the bankruptcy court to allow it to defer its rent payments beyond section 365(d)(3)’s 60-day period. CEC argued that it should not be required to pay rent for properties from which it receives “no—or a significantly limited—benefit” because of the pandemic and related governmental orders.
Somewhat unceremoniously, the bankruptcy court rejected CEC’s arguments, reasoning that section 365(d)(3) “expressly prohibits delays beyond sixty days” after the petition is filed and “does not provide the Court with authority to alter lease obligations beyond that sixty-day window.” See Section 365(d)(3) (“but the time for performance shall not be extended beyond such [initial] 60-day period.”).
Notably, the CEC court did not order the debtor to begin making rent payments on the 61st day, nor did it address what happens if the debtor fails to comply with 365(d)(3)’s direction, stating that its “equitable powers will be tested at the remedy stage.” By contrast, the bankruptcy court in In re Pier 1 Imports, Inc., 615 B.R. 196 (Bankr. E.D. Va. 2020) held that even though section 365(d)(3) does not provide a remedy for the debtor’s failure to timely pay rent, other provisions of the bankruptcy code give the landlord an administrative expense claim for such failure that must be paid on the effective date of the plan under section 1129(a)(9)(A). In neither case did the bankruptcy court remedy non-payment of rent accruing during the first 60 days of the case by ordering immediate payment of that rent.
On balance, the decision in CEC is a victory for landlords, although it is unclear how much tangible benefit it provides. CEC is the first published decision in which a bankruptcy court determined that a court may not utilize its equitable powers under section 105(a) to sidestep the express language of section 365(d)(3) and defer a tenant debtor’s obligations under a lease beyond the initial 60 days of the case. CEC recognizes that while the Bankruptcy Code provides various tools to assist a debtor’s reorganization, it simultaneously protects landlords from an involuntary extension of credit to their tenants through rent deferrals.
But, while it recognized the 60-day limit on the “rent holiday” afforded by section 365(d)(3), the CEC court did not order rent to be paid once that period expires, nor did it discuss what remedies may be available to landlords for nonpayment of rent. In that regard, we do not think that CEC changes the landscape as we believe courts will continue to grant 60-day rent holiday motions but will generally not further extend that rent abatement. We do expect future cases to address landlord remedies for unpaid post-petition rent and anticipate that courts may adopt the rule recently enacted for small business cases of granting landlords an administrative expense claim that must be paid on the effective date of the plan.
1 See, e.g., In re JC Penney Co., Inc. et al, No. 20-20182 (DRJ) (Bankr. S.D. Tex. May 28, 2020) (Dkt. No. 338); In re CraftWorks Parent, LLC, No. 20-10475 (BLS) (Bankr. D. Del. May 20, 2020) (Dkt. No. 174); In re Chinos Holdings, Inc., No. 20-32181 (KLP) (Bankr. E.D. Va. May 4, 2020); In re True Religion Apparel, Inc., No. 20-10941 (CSS) (Bankr. D. Del. Apr. 13, 2020); In re Pier 1 Imports, Inc., No. 20-30805 (KRH) (Bankr. E.D. Va. March 31, 2020) (Dkt. No. 438).
2 See, e.g., In re Brooks Brothers Grp., Inc. et al., No. 20-117855 (CSS) (Bankr. D. Del. July 16, 2020) (Dkt. No. 162); In re CEC Entertainment, Inc., No. 20-33163 (MI) (Bankr. S.D. Tex. June 30, 2020) (Dkt. No. 162); JC Penney, No. 20-20182 (DRJ) (Bankr. S.D. Tex. May 28, 2020) (Dkt. No. 338); Chinos Holdings, No. 20-32181 (KLP) (Bankr. E.D. Va. May 4, 2020); True Religion, No. 20-10941 (CSS) (Bankr. D. Del. Apr. 13, 2020); Pier 1 Imports, No. 20-30805 (KRH) (Bankr. E.D. Va. March 31, 2020) (Dkt. Nos. 438 and 562).