For Whom the Rent Tolls: Decision Suggests Tenants May Be Relieved of Rent Obligations
Client Alerts | August 18, 2020 | Creditors’ Rights and Bankruptcy Litigation | Real Estate Litigation | Leasing
A recent unreported decision by a New York bankruptcy court suggests that commercial tenants whose operations were suspended under mandatory shutdown orders as a result of the pandemic may be able to escape their rent obligations that relate to the shutdown period.
The debtor in the case, In re Edison Price Lighting, Inc., is a manufacturer of high-end architectural lighting, operating out of a plant in Queens, New York. The plant was closed pursuant to Governor Cuomo’s “New York State on PAUSE” order on March 20, 2020. Edison filed a chapter 11 petition on May 1, 2020. Substantially all of Edison’s cash was subject to a security interest held by Citibank. Use of cash collateral was permitted pursuant to an approved budget, which did not include payment of rent. The plant reopened on June 19 for cleaning and small-scale operations.
The landlord then filed a motion seeking immediate payment of unpaid post-petition rent (for the months of May, June and July) and for relief from the automatic stay in order to evict the debtor. The debtor, supported by Citibank, sought a deferral of rent obligations, citing to cases such as Modell’s (discussed in our prior alert), in which the case was suspended due to the coronavirus pandemic, and Pier 1, in which the debtors’ rent obligations were deferred.
Bankruptcy Law Rulings
Judge Drain denied the landlord’s motion. He ruled that while section 365(d)(3) requires a debtor to timely perform post-petition lease obligations, the landlord’s ultimate remedy for breach is an administrative priority claim. He declined to direct the debtor to pay immediately the late post-petition rent because the debtor might be administratively insolvent, and because the cash was subject to a lien. He observed that, as a practical matter, the only way for the landlord to get paid was for the debtor to either be sold as a going concern or to generate sufficient revenues to resume payments in full. In the interim he required only that the debtor provide adequate protection to the landlord by insuring the property and paying taxes.
Judge Drain then went on to raise an issue that he noted had not been addressed in Modell’s or Pier 1. Specifically, he considered whether the debtor’s obligation under section 365(d)(3) to “timely perform all the obligations of the debtor … arising from and after the order for relief under any unexpired lease of nonresidential real property” are subject to a defense that the debtor could raise under New York law based on a doctrine sometimes called the “impossibility doctrine” or the “frustration doctrine.”
Judge Drain found that this doctrine creates an implied covenant in contracts and leases, and that it can be raised by a tenant “where an unanticipated event occurred that could be shown to have precluded performance.” As the Governor’s executive orders made it impossible for the debtor to realize “the very purpose of the lease, i.e., to occupy the premises and manufacture the goods there,” he concluded that the doctrine would apply “at least for the duration of those orders.”
Judge Drain’s decision did not specifically rely upon express provisions of the lease, although he suggested that certain lease provisions regarding condemnation and the scope of the landlord’s remedies might be relevant. He also did not invoke the doctrine of force majeure, which some have suggested might be applicable to contracts affected by the pandemic (as discussed in a prior client alert). He conceded that none of the parties had raised this issue, and invited them to file briefs before he would issue a definitive decision.
Judge Drain’s decision raises several questions.
- Is the rent claim deferred or denied? The decision does not specifically address this point, and it may be clarified in the final decision after briefing (no briefing schedule has been set, and no such briefs have been filed). It seems that the better reading of the decision is that if the doctrine is found to be applicable the rent in question would not have to be paid at all.
- How long does the period of impossibility last? The debtor reported that even after it was permitted to re-enter the factory it had to devote some time to cleaning and retro-fitting the premises. The debtor might argue that its period of frustration lasted until it was able to resume operations.
- How broadly applicable might this ruling be? It appears that this principle could be applied to any business that was required to close for a period of time. The scope of the Governor’s orders has varied in different parts of New York, and applies differently to different businesses, but many businesses (for example, movie theaters) are still totally closed, and other businesses (for example, restaurants) have been permitted to operate only with restrictions that were not contemplated when leases were signed. In addition, many commercial leases contain provisions (for example, force majeure clauses) that could provide landlords with arguments that may not have been available to the Edison landlord.
- Is a bankruptcy required? This case is a bankruptcy case, but the relevant doctrine is based on state law rather than bankruptcy law, so it would appear that it could be raised by tenants that have not filed bankruptcy petitions.
- Can this doctrine be raised in other states? On its face this decision is specific to New York, as it is based on orders of New York’s governor and New York caselaw. But there have been similar orders in many other states, and the “impossibility” doctrine is an ancient common law rule that has been incorporated in the statutes or common law of many other states.
The impossibility doctrine may be risky to raise for a non-bankrupt tenant. A debtor in bankruptcy, like Edison, is protected against eviction by the automatic stay, which applies only in bankruptcy cases. In addition, many commercial leases saddle the tenant with the landlord’s litigation expenses, and while some bankruptcy decisions limit the debtor/tenant’s exposure to the landlord’s legal fees, such protection, too, applies only in bankruptcy cases. In short, a tenant should carefully review its options with counsel before raising the impossibility doctrine as a defense to rent.
Judge Drain’s decision also does not address the broader political, social and economic issues implicated in a determination that rent might not be due for the shutdown period. The landlord undoubtedly relies upon the collection of rents to pay its expenses, and it is not clear whether a building owner can, in turn, use the impossibility/frustration doctrine against its own creditors.