Landlords are not always entitled to an Administrative Claim for non-payment of rent in a bankruptcy proceeding. When a debtor in bankruptcy rejects a contract, it's considered a breach of the contract that occurred before the bankruptcy was filed. It is not considered a termination, but it does end the contractual relationship with the non-debtor counterparty, who is then left with a claim for damages.
Non-Debtor Damages and the Bankruptcy Code
Typically, any damages sustained by the non-debtor counterparty, such as a landlord, are treated as a general unsecured claim extending post-petition, unless the non-debtor counterparty can show that the services or goods it provided benefited the estate. And in such case, the claim arising post-petition can be treated as an administrative claim under Section 503(b)(1) of the Bankruptcy Code, which is the highest priority claim in a Chapter 11 proceeding.
Section 365(d)(3) of the Bankruptcy Code provides:
(3) The trustee shall timely perform all the obligations of the debtor, except those specified in section 365(b)(2), arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title. The court may extend, for cause, the time for performance of any such obligation that arises within 60 days after the date of the order for relief, but the time for performance shall not be extended beyond such 60-day period. This subsection shall not be deemed to affect the trustee's obligations under the provisions of subsection (b) or (f) of this section. Acceptance of any such performance does not constitute waiver or relinquishment of the lessor's rights under such lease or under this title.
11 U.S.C. § 365(b)(3).
Section 503(b)(1) in pertinent part provides:
(b) After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including—
(1) (A) the actual, necessary costs and expenses of preserving the estate including—
11 U.S.C. § 503(b)(1) (emphasis added).
So, to be clear, Sections 365(d)(3) and 503(b)(1) of the Bankruptcy Code do not create an absolute right of a rejected contractual claim being treated as an administrative claim including landlords seeking rent under a lease when the lease is automatically rejected after bankruptcy is filed.
Was the Landlord Entitled to an Administrative Claim?
In re Jughandle Brewing Co., LLC, 23-15703 (Bankr. D.N.J. June 3, 2024), the bankruptcy judge reviewed whether a landlord was entitled to an administrative claim for rent due post-petition and before the lease was rejected.
At the time the debtor filed its Chapter 7 (liquidation) petition, most of the debtor's personal property was located in leased property. The leased property was fully liened up leaving no real value to the bankrupt estate.
Not only did the trustee not move to reject the lease, but the landlord made no attempt to move to reject the lease until two weeks before the lease would automatically be rejected under Section 365(d)(4) of the Bankruptcy Code.
The bankruptcy judge noted that Section 365(d)(3) requires the trustee to timely perform all the obligations of the debtor . . . until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title...." Yet, even though the bankruptcy code is silent as to the consequences of the trustee failing to pay post-petition rent, the bankruptcy judge noted that "[t]he allowance of an administrative claim where a trustee fails to perform under § 365(d)(3) is the presumed remedy for a majority of courts throughout the country."
Further, for there to be an administrative claim, per Section 503(b)(1), there must be a showing that the estate benefited from such services or goods.
So, with the case being a Chapter 7 liquidation case and there being no value in the personal property kept in the lease premises, what if any benefit did the estate receive? Here, the Judge noted that she can craft a remedy under Section 105(a) that allows the court to "... issue any order, process or judgment that is necessary or appropriate to carry out the provision of this title [11]."
Here the bankruptcy judge recognized that even though there was no value to the estate because that business was not operating and the trustee had no interest in the personal property located in the leased space, there was a perceived benefit to the estate by "allowing the Trustee time to perform his investigation as to whether the lease has any value."
With this in mind, utilizing the equitable powers under Section 105(a), the bankruptcy judge granted the landlord an administrative claim, not for the 120 days for which a lease is automatically rejected, but only for the stub rent of $11,000.00. Stub rent is the rent owed by the debtor from the date of filing until the end of the first month of the bankruptcy or until the first date a lease payment is due.
Landlords Should Not Still Idly
The takeaway from this case is that it makes sense for the landlord to not sit on its rights expecting that it will be entitled to an administrative claim for the amount of the rent owed through the date of rejection. At the end of they day, the landlord should remain actively engaged and force assumption and rejection if the debtor or trustee have not timely paid post-petition rent and in doing so, the landlord should seek adequate assurance of future performance if the Trustee or debtor opposes the landlord's requested relief.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
