Landlord Stub Rent Claim: Administrative Priority Or Not?

In re Oreck Corp., 506 B.R. 500 (Bankr. M.D. Tenn. 2014)

A commercial landlord sought allowance of its claim for “stub rent” as an administrative expense – either because of the requirement that lease obligations be timely performed prior to assumption or rejection of a lease or under the general administrative expense provision.

Take a typical case in which rent is paid in advance under the lease, rent has become due for a particular month (or other period), and a bankruptcy is filed during the month. Stub rent refers to rent for the period between the date the bankruptcy is commenced and the first date that rent is due post-petition. Since the rent for the period that includes the stub period first became due pre-petition, this leads to an argument that the claim for that month’s rent is a pre‑petition claim that should be treated as an unsecured claim.

However, for a commercial lease Section 365(d)(3) provides: “The trustee shall timely perform all the obligations of the debtor … 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 landlord argued that there is a post-petition obligation to pay rent for the stub period under Section 365(d)(3), so that the stub rent should be considered an administrative priority expense as opposed to a pre‑petition unsecured claim. Alternatively, the landlord argued that payment for post-petition occupancy should be treated as an administrative expense under Section 503(b)(1), which among other things provides that the “actual, necessary costs and expenses of preserving the estate” should be allowed as administrative expenses.

In determining when stub rent arises for purposes of Section 365(d)(3), courts have split with some adopting an accrual or proration theory and others adopting a billing date approach:

  • Under the billing date approach, the date that the rent obligation becomes due determines when the obligation arose. If the rent is due on the first of the month, and the bankruptcy is filed later in the month, then the rent for that month is a pre‑petition claim and does not arise “from and after” the commencement of the bankruptcy.
  • In contrast, under the accrual or proration theory, when a month’s rent is paid in advance, it is prorated over that month. So, if rent is due on the first of the month and bankruptcy is filed on the tenth of the month, then ~1/3 of the month’s rent is pre‑petition and ~2/3 is post-petition and thus entitled to administrative expense priority.

Although it found no controlling precedent on precisely this issue, the bankruptcy court noted that the 6th Circuit addressed an analogous question with respect to the end of the obligations under Section 365(d)(3). The obligation to timely perform runs until a lease is assumed or rejected. In a case where a full month’s rent was due on the first of the month and the debtor rejected the lease on the second of the month, the issue was whether the full month’s rent should be given priority as an administrative claim. The 6th Circuit held that it did – effectively adopting a billing date approach.

The landlord in this case attempted to argue that the decision was applicable only to the end of the period and should not apply to the beginning of the period, but the bankruptcy court was not persuaded. While noting that accrual courts are concerned that a billing date approach allows a debtor to manipulate the system by timing its bankruptcy, the court noted that lease obligations are “merely one more factor to consider” in determining the timing of a petition.

With respect to the argument that stub rent should be allowed under the general administrative expense provision in Section 503(b)(1), the court first noted that there is a split on whether Section 365(d)(3) supersedes Section 503(b)(1) with respect to rent claims.

Section 365(d)(3) requires timely performance of the lease terms regardless of whether they qualify as “actual, necessary costs and expenses of preserving the entire estate.” However, that does not necessarily mean that a stub rent claim that doesn’t come within the scope of Section 365 could not be allowed under Section 503(b)(1) if a landlord can demonstrate that the post-petition occupancy conferred an actual and necessary benefit to the estate.

While acknowledging that the published 6th Circuit precedent noted above did not address the interaction of Section 365(d)(3) and Section 503(b), thus leading to a “temptation to wade into this debate,” the court decided that “there is a fundamental reason not to get wet in this case.” Namely, the 6th Circuit signaled in an unpublished decision that a landlord in this circumstance cannot satisfy the conditions for allowance of an administrative expense even if 503(b)(1) is available when Section 365 is not.

The critical point is that the lease obligation to pay rent arose pre‑petition. In order to qualify as an administrative expense, an obligation must both arise post‑petition and provide benefit to the estate. This is consistent with the theory that a creditor must have been induced by the post‑petition debtor in possession, not the pre‑petition debtor, in order to be entitled to an administrative expense claim. The landlord’s attempt to get around this argument by claiming that it was asserting compensation for occupancy and not a lease claim was rejected as an “unsustainable illusion.”

Thus, since the court classified the rent claim for the month that straddled the filing of the bankruptcy as a pre‑petition claim, the landlord was out of luck on both theories.

As discussed in the opinion, these issues are far from settled. The priority of a claim for stub rent can go either way depending on the jurisdiction. In a case with significant lease obligations, it is at least one factor that a debtor could consider in making a decision about both timing and location (to the extent alternatives are available) of a bankruptcy filing.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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