In past print editions of Absolute Priority, we regularly reported on developments concerning the application of Bankruptcy Code provisions to the rights of landlords that lease non-residential real property to debtors operating in Chapter 11. While these discussions typically focused on the treatment of a debtor’s rental obligations (and in particular, so-called “stub rent” owed by a debtor for the period beginning on the day that the bankruptcy petition is filed through the end of the month), considerable non-rental charges can also accrue under a lease on a postpetition basis. It is not always clear under the Bankruptcy Code whether these charges should be entitled to administrative priority over general unsecured claims.
In In re Davenport Beverage Corporation, Case No. 12-43583 (MSH) (Bank. D. Mass. Feb. 12, 2014), the Bankruptcy Court for the District of Massachusetts addressed this issue in the unusual context of a debtor and landlord that continued performing under a lease after the lease was deemed rejected by operation of law.
As an initial matter, neither the landlord nor debtor in Davenport appeared to recognize that the lease had been deemed rejected, despite the fact that the Court issued an order stating as much. Under the Bankruptcy Code, debtors have 120 days (subject to a 90-day extension for cause, or a longer extension upon the written agreement of the parties) to assume a lease of non-residential real property, or the lease will be rejected by operation of law. Here, the parties filed a joint motion to extend the time to assume or reject the lease, but the Court denied their motion because they did not file it until after the 120-day deadline had passed.
Despite the fact that the Court held that the lease was deemed rejected 120 days after the commencement of the case, the debtor did not vacate the premises for another 4 months, and both the landlord and debtor continued to perform under the lease. After the debtor finally vacated the premises and the landlord entered into a new lease with the purchaser of the debtor’s assets, the landlord filed an administrative expense claim for charges totaling approximately $50,000, which included, among other things: penalties for the late payment of rent and repair and maintenance charges. Some of the late-payment penalties and repair and maintenance charges accrued before the lease had been deemed rejected, while other portions of the claim accrued during the post-rejection period in which the debtor occupied the leased premises.
To determine the appropriate treatment of the charges, the Court considered both Sections 503(b) and 365(d) of the Bankruptcy Code. Under section 503(b), an expense is entitled to administrative priority if it arose postpetition and was reasonable and beneficial to the debtor’s estate. Under 365(d)(3), a debtor is required to timely perform all obligations under a lease until the lease is rejected.
Consistent with section 365(d)(3), the Court first held that charges arising before the lease was deemed rejected were allowed administrative claims, concluding that the landlord was entitled to recover late fees, maintenance charges, and any other obligations under the lease that accrued before the lease was rejected, regardless of whether they were reasonable or beneficial to the estate. It was simply of no moment that the debtor’s estate did not benefit from the incurrence of the late fees or certain of the repair charges. It was also irrelevant under section 365(d)(3) that the maintenance charges attributable to snow plowing on the leased premises were, according to evidence presented by the debtor, egregiously above market ($250 dollars per inch of snow versus $25 dollars per inch of snow).
With respect to the portion of the landlord’s claim for fees and expenses that accrued after the lease was deemed rejected, however, the Court applied section 503(b) and undertook the much more nuanced analysis that section requires, ultimately concluding that some of the fees should be allowed as administrative expenses and others should not. The Court declined to grant administrative expense priority to the late-payment charges that accrued after the lease was rejected because they did not benefit the debtor’s estate, but concluded that certain maintenance charges, such as snow plowing, did benefit the estate. However, even after finding that the snow plowing charges benefited the estate, the Court was also required under section 503(b) to determine whether the charges were reasonable. In undertaking this analysis, the Court was not bound by the terms of the lease and refused to award the full amount sought by the landlord, instead allowing a reduced amount of the plowing fee based on the market rate of $25 per inch (as opposed to the contract rate of $250). The Court also determined that certain repair and maintenance charges provided no benefit the debtor because they occurred after the debtor vacated the premises.
The facts in the Davenport case are unique in that the claims at issue concerned a period in which the debtor and landlord continued to perform under a lease that had been deemed rejected. Nevertheless, the Judge’s conclusions in Davenport comport with commonly held treatment of sections 365 and 503, and the case provides a useful reminder to both landlords and debtors about the important differences in the operation of 365(d) and 503(b).