• Bankrupt Tenant May Have To Pay Full Rent For Month In Which Lease Was Rejected
  • October 16, 2003 | Author: Harris Ominsky
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • A recent case by the Seventh Circuit Court of Appeals has established that a bankrupt tenant may have to pay the remainder of a full month's rent, even though it covered a period of time beyond the tenant's rejection of the lease. HA-LO Industries, Inc. v. CenterPoint Properties Trust, No. 02-4331 (7th Cir. 9/3/03). In that case, the tenant was renting an office building for $660,000 a month, due on the first day of each month. After the tenant filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code, it obtained a Bankruptcy Court order permitting the tenant to reject the lease, at its option, effective on thirty days written notice to the landlord. On October 3, 2001 the tenant decided to exercise its option, and gave notice that it would vacate the property and reject the lease effective November 2, 2001. Since that date was later than November 1, when the monthly rental payment became due, the landlord took the position that the tenant was obligated to pay rent for the whole month of November even though it vacated the property by November 4.

    On the other hand, the tenant took the position that it was obligated to pay only $60,000, which was a prorated payment of rent for the three days during November that it planned to occupy the office building.

    When Rent "Arose"

    The Bankruptcy Court and the U.S. District Court confirmed the landlord's position and those decisions were affirmed by the United States Court of Appeals for the Seventh Circuit. The issue revolved around Section 365(d)(3) of the Bankruptcy Code, which provides that the trustee, or, as here, the debtor in possession must satisfy all rent obligations under a lease "arising...after the order for relief" as those obligations become due "until such lease is assumed or rejected...."

    The Circuit Court concluded that since the rent for any given month is payable in advance on the first day of the month, under the terms of the lease the tenant's obligation for November rent "arose" on November 1. Since at that time the tenant had not yet effected its rejection of the lease, under Section 365(d)(3) the tenant was therefore obligated to pay the entire November rent on November 1.

    The tenant had argued that an earlier decision In Re Handy Andy Home Improvement Centers, Inc., 144 S.3d 1125 (7th Cir. 1998), compelled the court to find that rent should be prorated so that the tenant is liable only for those few days of November it occupied the property. The court rejected that argument and distinguished the Handy Andy case because that involved real estate taxes and not rent. Also, those real estate taxes had in part accrued pre-petition while Handy Andy occupied the property, but were not billed to Handy Andy until after the start of the post-petition period and before Handy Andy's rejection of the lease.

    Treat Bygones as Bygones

    In making that distinction the court stated: "we held in Handy Andy that the portion of taxes that accrued during Handy Andy's pre-petition occupancy therefore had arisen pre-petition, and thus were akin to 'sunk costs' that are not chargeable to Handy Andy even though billed post-petition. "In economic terms, the prioritization of post-petition debt enables the debtor (or trustee) to ignore sunk costs -- treat bygones as bygones -- and to continue operating as long as the debtor's business is yielding an economic profit."

    The court held that unlike a portion of real estate taxes that accrued and therefore arose pre-petition, HA-LO challenges paying a full month's rent obligation that arose entirely post-petition and before rejection of the lease, but which covers in part a period of time that extends beyond rejection of the lease. It stated "post-petition rent covering a period of time that extends into the postrejection is 'not a sunk cost that relates to a time before the bankruptcy case, but a charge for the consumption of a resource during the administration of the case, and costs of administration must be paid.'"

    The court pointed out that Handy Andy acknowledged that landlords, unlike other creditors, are "forced to deal with [their] bankrupt tenant[s] on whatever terms the Bankruptcy Court impose[s] 'because landlords cannot evict their tenants." It also emphasized that based on the legislative history, Congress passed Section 365(d)(3) to relieve landlords of the uncertainty of collecting rent fixed in the lease, properly and without legal expense, during the awkward post-petition pre-rejection period.

    Lease Language

    The tenant made other arguments based on the lease itself. It argued that even if Section 365(d)(3)does not allow for proration, the lease should be read in a way that requires proration. The tenant pointed out that the lease specifically provides for proration under other circumstances, where occupancy may be for less than a full month. For example, the lease provides for proration in the first month, in the last month when the landlord terminates the lease, when the premises are destroyed or left uninhabitable and when the premises are condemned. However the court responded that the lease does not specifically call for proration in a situation like the HA-LO case, where the debtor in bankruptcy rejects a lease. Based on that, the court rejected the tenant's argument and pointed out that the lease contains a merger clause which states that the lease is the entire agreement between the parties and "fully and completely expresses their agreements."

    In addition, the lease provided: "The Annual Base Rent shall be paid in advance, in 12 equal monthly installments, commencing on the Commencement Date (prorated for any partial month) and continuing on the first day of each month thereafter for the balance of the term of the lease ...." (Emphasis added). The tenant also maintained that under this provision the tenant's obligation is to pay only prorated rent for any partial month during the period that the lease is in force, and not just the month in which the lease begins. However, the lower courts rejected that argument and, since HA-LO failed to raise that issue on appeal, the Circuit Court held that the tenant thereby waived any claim of error on this issue.

    The HA-LO case would suggest certain planning tips to parties in commercial leases. From the tenant's perspective, it appears that it could have timed its vacation of the property and rejection of the lease a little differently. If in this case it had been able to reject the lease as of October 31, instead of a few days later, it could have saved itself over $600,000.

    Moreover, under certain circumstances a tenant may be able to time the bankruptcy filing to save money. For example, if a substantial monthly rent payment becomes due on the first of the month, the tenant could file on the second of the month to make that payment a pre-petition obligation.

    Also, it seems that if the lease had made it clear that rent must be prorated in bankruptcy or other terminations, as in the other listed situations provided in the lease for partial months, the tenant could have succeeded in its arguments.