In a recent Delaware ruling, Judge Mary F. Walrath declines to follow the Fifth Circuit and holds that “a minority shareholder has [no] more right to block a bankruptcy… than a creditor does.”
This is the sixth in a series of alerts on insolvency topics affecting real estate. In this alert, we evaluate the decision, In re Hitz Restaurant Group, where the Bankruptcy Court ruled that the Illinois Governor’s Executive Order, temporarily barring on-premises food service and consumption, triggered the force majeure language, thereby partially absolving the tenant-debtor from paying its rent. We conclude that Hitz will likely be limited to the facts and force majeure language presented, and that similar force majeure language may not be interpreted in other cases as it was in Hitz.
In June 2020, the United States Bankruptcy Court for the Northern District of Illinois issued its decision, In re Hitz Restaurant Group (No. 20-B-05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 3, 2020)). The Court held that the Illinois Governor’s Executive Order, issued in response to the ongoing COVID-19 pandemic, triggered the force majeure clause of a lease and excused part of the tenant’s rent payment obligations. For some, this decision was surprising because force majeure clauses usually do not excuse, wholesale, payment obligations.
The case began when the tenant-debtor, Hitz Restaurant Group, failed to pay monthly rent for its restaurant premises at 825 S. State Street, Chicago, Illinois, and the landlord-creditor, Kass Management Services (as agent for South Loops Shops), sought to evict. The tenant filed for chapter 11 bankruptcy on February 24, 2020, automatically staying any eviction proceeding. The filing was just weeks before Illinois Governor J. B. Pritzker issued Executive Order 2020-7 on March 16 which, among other things, prohibited businesses from serving food or beverages for on-premises consumption (as later extended, the Executive Order).
The landlord petitioned the Court for (i) relief from the stay under 11 U.S.C. § 362 (ultimately granted, as discussed below) and, failing that, (ii) enforcement of the tenant’s duty to pay post-petition rent under 11 U.S.C. § 365(d)(3), which requires the tenant’s timely performance of all lease obligations arising during the bankruptcy case until the lease is accepted or rejected. The tenant claimed the lease’s force majeure clause excused its performance under the lease.
The force majeure clause in the lease (as quoted in the Court’s decision) specified:
Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by . . . laws, governmental action or inaction, orders of government . . . . Lack of money shall not be grounds for Force Majeure.
The Court found the Executive Order “unambiguously triggered” the lease’s force majeure clause and partially excused the tenant’s obligations to pay post-petition rent due after the Executive Order was issued in mid-March 2020. Relying on Illinois state law, the Court classified the Executive Order as a “governmental action” and an “order” as contemplated in the force majeure clause. Additionally, the Court found the Executive Order “hindered” the tenant’s ability to perform and was “unquestionably” the “proximate cause” of the tenant’s inability to pay rent.
Further, the Court summarily rejected the landlord’s argument that failure to pay due to a lack of money is not grounds for force majeure under the terms of the lease. Instead, the Court agreed with the tenant’s position that the Executive Order was the proximate cause of its failure to pay rent.
Despite referring to the force majeure clause as unambiguous, the Court addressed in a footnote the interplay between two parts of the clause, (i) the sentence that excludes “lack of money” and (ii) the language in the clause saying that governmental action triggers force majeure. The Court’s footnote says the “lack of money” is more general than “government action” and so, under the rule of construction as identified and applied by the Court, the latter would prevail.
The landlord advanced two additional arguments that the force majeure clause had no effect on the tenant’s obligations to pay post-petition rent, both of which the Court also rejected. First, the landlord argued the Executive Order did not shut down the banking systems or post offices; therefore, it did not prohibit the tenant from mailing rent checks. Second, the landlord asserted that the tenant’s failure to apply for a Small Business Administration loan prevented the tenant from relying on the force majeure clause. The Court found these arguments lacked a foundation in the language of the clause and were unsupported by case law. These arguments could have been grounded in language in the lease’s definition of force majeure excluding causes “not within the reasonable control of the party . . . .” That language appeared in the lease available in the pleadings but was not quoted in the Court’s opinion.
The decision was not by any means a total loss for the landlord. The landlord also petitioned the Court to modify the automatic stay under 11 U.S.C. § 362(d)(1), which provides that the Court “shall grant” relief from the stay “for cause,” including the lack of “adequate protection” of the holder of an interest in property.
The Court concluded that the tenant did not adequately protect the landlord’s interests when the tenant failed to pay any post-petition rent. Because the Executive Order did not prohibit all restaurant services and instead encouraged businesses to provide carry-out and delivery options, the force majeure clause only partially relieved the tenant’s payment obligations. The Court reduced the post-petition rent amount, real estate taxes, and maintenance fees due for the period following the Executive Order by 75%, a reduction in proportion to the estimated area of the premises unavailable to the tenant to generate revenue under the Executive Order’s dining restrictions.
In total, the Court ordered the tenant to pay the full rent amount, real estate taxes, and maintenance fees for March (i.e., obligations arising after the chapter 11 filing and payable before issuance of the Executive Order), plus 25% of the same lease obligations owed for April, May, and June.
In the end, the tenant apparently did not pay even the reduced rent, and, on June 23, 2020, the Court granted the landlord lift-stay relief.
As the effects of the COVID-19 pandemic continue to unfold across the country and in the courts, In re Hitz Restaurant Group likely will not be instructive for every landlord-tenant dispute arising from the pandemic. First, the ruling is specific to the facts of this case and will likely be difficult to replicate. For example, outcome-determinative details include the timing of the tenant’s chapter 11 filing and the language of the lease’s force majeure clause. Thus, future landlord-creditors may distinguish their case to achieve a different outcome. Second, the force majeure issue arose in the context of dual motions, including a lift-stay motion where the Court seemed inclined to err on the side of giving the tenant-debtor every chance to avoid having the stay lifted. Third, other courts may find a lack of money, not the Executive Order (or a functional equivalent), proximately caused the tenant’s default. Relying on the language of the force majeure clause, specifically the “lack of money” exception (or failure to mitigate), a court may hold the clause is not triggered and does not excuse rent payment obligations. Fourth, the ruling applied Illinois law and may be less likely to be followed elsewhere.
For more information, please reach out to your regular Pillsbury contact or the authors of this client alert.
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