A commercial landlord asked the bankruptcy court to allow its administrative expense claim in a chapter 11 case. The lease was deemed rejected while the bankruptcy case was pending, and the court’s decision turned in part on whether the expenses arose prior to or after rejection.
This case highlights the distinction between (1) administrative expense claims relating to timely performance of a debtor’s obligations prior to assumption or rejection of a lease under Section 365(d)(3) of the Bankruptcy Code, and (2) claims relating to the expenses of administration of the estate under Section 503(b)(1)(A).
In particular, Section 503(b)(1)(A) provides that administrative expenses include “the actual, necessary costs and expenses of the estate,” while Section 365(d)(3) provides (emphasis added):
The trustee shall timely perform all the obligations of the debtor, except those specified in Section 365(b)(2) [relating to insolvency, etc.], 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 appeared to be miffed by the fact that both the landlord and the debtor demonstrated “a shocking lack of fidelity to positions taken on the record” in that both parties did a flip-flop on whether the lease had been terminated prepetition. This was aggravated by the fact that they “appeared to have forgotten” a joint motion to extend time to assume or reject the lease, which the court denied as being too late, with the result that court found that the lease was deemed rejected as a matter of law 120 days after the case was filed.
Thus, “[t]he parties’ bickering over whether or when the lease was rejected (totally oblivious to my prior ruling) and what is the proper measure of §502(b)(6) [rejection] damages is nothing more than a side show.” Instead, the proper analysis was whether the late charges, repairs and maintenance costs, and attorneys’ fees should be accorded administrative expense status, which in turn required consideration of the extent to which the claims arose before or after the deemed rejection date.
Turning first to claims under Section 365 relating to the period between the bankruptcy filing and deemed rejection of the lease, the court concluded that the reference to requiring performance of all lease obligations “notwithstanding section 503(b)(1)” had the effect of (1) eliminating the requirement for an order authorizing payment, (2) eliminating the need to show that the bankruptcy estate benefited from the expense, and (3) allowing landlords to assert claims based on the terms of the lease, as opposed to establishing the value of the benefit to the estate.
Under this approach, the court found that the landlord was entitled to an administrative expense claim for base rent, late fees, and snow plowing charges as due under the terms of the lease for this period. In reaching this conclusion, the court rejected arguments that (1) the late fees did not confer any benefit on the estate and (2) the snow plowing charges were unreasonable.
Turning to the post-rejection period, the debtor’s use of the leased property to run its business provided a tangible economic benefit to the estate. Generally rent under a lease is the appropriate charge (although that might not be the case if it is shown that the rate is unreasonable). So, the landlord was entitled to base rent as an administrative expense claim for the period that the debtor continued to occupy the space post-rejection. On the other hand:
- Late charges: did not provide any benefit to the estate.
- Snow plowing expenses: The landlord’s contractor charged $250 per inch of snow, while the debtor contended that the going rate was $20 to $25 per inch. In other words, the landlord was charging 10 times more than was justified. So, the court allowed only the standard going rate of $25 per inch as the value of the benefit conferred on the estate. It noted that $250 per inch might have been actual expenses, but it was not necessary.
- Repair and maintenance expenses for the roof, parking lot and septic system: It appears that these all occurred after the debtor’s buyer completed its purchase and entered into a new lease with the landlord. Since the expenses were not paid while the debtor was in possession, the estate did not benefit from the work. (The court also noted that there was no allegation that the buyer conditioned its purchase on the physical condition of the roof or parking lot or on the repair and maintenance work that was performed. If that had been the case, it is possible that those expenses could have been included as administrative expenses.)
- Legal fees: The fees included in the claim related to prepetition work in connection with a state court eviction proceeding. At best, those should have been included in the landlord’s prepetition claim.
Thus, the court allowed an administrative expense claim for a total of ~$7,300 out of the ~$58,400 requested (which resulted in a judgment for $691.60 due to a credit to the debtor for an overpayment of rent).
Although a debtor may wish to delay the decision on whether to assume or reject a lease, this case illustrates that there may be a cost if it ultimately rejects the lease: The amount that a landlord will be entitled to claim for timely performance under the lease prior to rejection will often be higher than a claim for these same expenses as Section 503(b)(1)(A) administrative expenses that benefit the estate.
Vicki R. Harding, Esq.