On December 14, 2020, Judge Marvin Isgur of the United States Bankruptcy Court for the Southern District of Texas, issued an important decision in the CEC Entertainment, Inc. (Chuck E. Cheese) bankruptcy case, Case No. 20-33163, denying the Debtors' motion to abate their obligations to pay post-petition rent due to government shutdown orders issued as a result of the COVID-19 pandemic. Memorandum Opinion [Dkt. No. 1492].
The Court held that the force majeure clause in each affected lease prohibited the Debtors from delaying payment of rent due to COVID - 19 shutdown orders, and that the common law doctrine of frustration of purpose does not apply, either because the force majeure clauses in the leases supersede application of the frustration of purpose doctrine, or because the purpose of each lease is not entirely frustrated.
The Court began its decision by noting that Section 365(d)(3) of the Bankruptcy Code requires debtors who are commercial real property lessees to timely preform their lease obligations during the pendency of their bankruptcy cases. The Court also noted that it could not override this statutory mandate. Consequently, the Court could not grant the Debtors' motion unless the lease terms or state law excused the Debtors' performance.
The Court found that the force majeure clauses in the leases at issue did not apply to an inability to pay rent or a failure to perform due to lack of funds.
The Debtors also relied in their motion on the doctrine of frustration of purpose as a basis to avoid paying rent. Because the force majeure provisions in the leases at issue allocated the risk that the purpose of the leases would be frustrated, however, the Court ruled that the Debtors could not rely on the frustration of purpose doctrine in these cases, either.
The Court also rejected the Debtors' argument that the leases had to specifically contemplate a pandemic in order for the force majeure clause to supersede the frustration of purpose doctrine, stating, "In CEC's mind, a doctrine whose application is predicated on the occurrence of unforeseen events can only be abrogated if the parties foresee and contract around the specific event. That is impossible." Memorandum Opinion at 17.
The leases at issue in the Court's decision were governed by North Carolina, Washington State and California law. Consequently, although the principles of state law enunciated in the Court's Memorandum Opinion will have application in many states, the Court specifically applied each applicable state's law in turn
North Carolina
Because the parties had allocated the risk of unforeseen events through the use of a force majeure clause, the doctrine of frustration of purpose under North Carolina law did not apply.
In addition, because the leases permitted the Debtors to use the leased premises for purposes other than the Debtors' preferred use as a Chuck E. Cheese restaurant, the purpose of the lease had not been frustrated.
Moreover, the Bankruptcy Court noted that the Debtors did not reject the leases in their bankruptcy case, but chose to retain their right to assume the leases for use after the pandemic subsided. Consequently, the Court concluded that any destruction of the value of the leasehold is temporary, not total, as would be required for the frustration of purpose doctrine to apply.
State of Washington
Similarly, under Washington law, the doctrine of frustration of purpose does not apply if, as here, the leases allocated the risk of frustrating events to one party or another.
Moreover, the Court found that under Washington law, the remedy for frustration of purpose equates to rescission of the contract. Consequently, if the frustration of purpose doctrine applied, the sole remedy would be rescission. The Court, therefore, could not reduce or postpone the Debtors' obligation to pay rent.
California
Similarly, the Court held that under California law, the frustration of purpose doctrine was not available where parties have contracted with reference to the frustrating event through the existence of a force majeure clause.
The Court also held that the doctrine of impossibility was not available to the Debtors because the COVID-19 regulations had no impact on the Debtors' cost of performance under the leases, which was unchanged. The Court pointed out that legal impossibility only exists when a thing can only be done at an excessive and unreasonable cost, which was not the case with respect to payment of rent under the leases.
The Court also found that frustration of purpose could not apply because the applicable government restrictions restricted, rather than destroyed, the purpose of Debtors' California leases, which allowed the Debtors "to operate any number of different businesses on the premises." Memorandum Opinion at 27.
Conclusion
Although the Court denied the Debtors' rent abatement motion, the Court did not order the Debtors' to pay the post-petition rent, as that issue was not before the Court on the Debtors' motion. The Court noted, however, that a remedy for non-payment in violation of Section 365(d)(3) of the Bankruptcy Code implicates the Court's equity powers under Section 105 of the Bankruptcy Code, leaving open the question of what relief the Court would grant if asked to compel the Debtors to make payment of the post-petition rent. As a result of the Court's decision, however, the Debtors' attempt to obtain a free option to retain their leased premises while waiting out the pandemic has been defeated. Even if the Court does not order the immediate payment of rent, the Debtors will have to pay the post-petition rent either as a cure cost upon assumption of the leases, or as an administrative expense on the effective date of the plan.
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