Left to right: Andrew Kassner and Joseph Argentina of Faegre Drinker Biddle & Reath.

The long term implications of the pandemic caused by COVID-19 and the resulting unprecedented drastic actions by state and municipal governmental entities in issuing "stay at home" and "shelter in place" orders has yet to be determined, but the short term effects are unfolding each day. Certain sectors of the economy have been effectively shut down. And the incredible disruption to the retail sector is obvious when one drives down main street or past a mall.

How bankruptcy courts address the goals of Chapter 11 under these circumstances has presented a huge challenge. In any retail proceeding, the obligations of a debtor to timely perform its post-petition obligations under the store leases is clear. But what happens during a global pandemic? The issue was recently addressed by the U.S. Bankruptcy Court for the Eastern District of Virginia in In re Pier 1 Imports, Case No. 20-30805-KRH (May 10, 2020), where the court was requested to allow the debtors to defer payments of post-petition rent for store locations. The court granted this request, and permitted the Pier 1 debtors to defer post-petition rent at many locations.

U.S. Bankruptcy Court Judge Kevin R. Huennekens began by observing "As the debtors aptly stated in the motion, the world has changed since the filing of these Chapter 11 cases … no constituency in these cases predicted that the world would effectively grind to a halt. But, so it did." The court further observed "Thus, the debtor in the bankruptcy cases at bar, like other Chapter 11 debtors throughout the nation, sought to find a way for their businesses to 'shelter in place' for a short duration while they determined whether and how to maximize value for their creditor constituents in light of a global pandemic."

A Process Blindsided by the Pandemic

Pier 1 filed its Chapter 11 cases on Feb. 17. The opinion describes how at that time, the debtors anticipated that the COVID-19 outbreak in China would temporarily impact inventory shipped from China. "These forecasted limited supply disruptions were nothing compared to what the next few months would bring," the court wrote. The debtors' revenue "dried up overnight."

In response, the debtors took steps to "shelter in place" while they plotted a course through the pandemic. They furloughed employees, closed stores, decreased salaries and negotiated rent deferrals with cooperative landlords. The opinion notes their efforts were not enough. The debtors requested additional relief to preserve the status quo and further reduce expenses, and filed an emergency motion seeking an order permitting only limited business operations for a short period of time. During this "limited operations period," the debtors would pay only critical expenses, which did not include rent payments for their closed stores. The debtors prepared to continue to pay insurance, utilities and monitored security systems at the leased premises.

The court granted the motion on a temporary basis, but scheduled a subsequent hearing for entry of a supplemental order. Many, many landlords objected to the motion. The court overruled all of them, and on May 5 entered a supplemental order extending the rent deferral period until May 31, reserving the possibility of additional extensions. On May 10, the Court issued the opinion in support of the supplemental order.

Extraordinary Relief for an Extraordinary Crisis

The court began its analysis by noting the debtors were not being permitted to avoid their obligation to pay rent, which would continue to accrue under the terms of each applicable lease. The debtors were only permitted to delay payment during the limited operations period. The court also stated it did not find the debtors' performance under the leases had been excused due to impossibility, impracticability, or frustration of purpose. Also, the debtors' property had not been taken by the government and subject to payment in exchange. The debtors anticipated reopening in June, and catching up on the deferred rent by July.

The court reviewed the relevant provisions of the Bankruptcy Code. First, the court acknowledged that Section 365(d)(3) requires a debtor-in-possession to timely perform all post-petition obligations arising under any unexpired commercial lease until the lease is assumed or rejected. The plain text of the statute required timely payment of post-petition rent. The debtors' emergency motion sought to defer that obligation. The court noted the apparent contradiction: "Without more, it would seem that such relief would be in express contradiction of section 365(d)(3) of the Bankruptcy Code." However, the court cited its own 2009 decision in In re Circuit City Stores that Section 365(d)(3) does not provide a separate remedy to effect payment. If a debtor fails to pay rent post-petition, the landlord is not entitled to immediate payment. Rather, it holds an administrative expense claim, which must be paid at plan confirmation along with all other administrative expense claims. The opinion observed that immediate payment of post-petition rent would elevate landlords' administrative claim to superpriority status ahead of all other administrative claims.

Next, the court considered whether the landlords were entitled to adequate protection of their interest in the leases. Section 363(e) of the Bankruptcy Code authorizes a creditor or third party to require a debtor to protect the third party's interest in the debtor property to the extent the value of the third party's interest is diminished during the bankruptcy case. The court concluded the Pier 1 landlords' interests in the leases were adequately protected. The Debtors' eventual payment of the rent would prevent a decrease in value of the landlords' interests. Also, the landlords were further protected by the debtors' continued payment of insurance, utilities, and security.

Finally, the court discussed the desperate situation. "COVID-19 presents a temporary, unforeseen, and unforeseeable glitch in the administration of the debtors' bankruptcy cases." The deferral of rent payments "paused" the cases to give them a chance to succeed for all creditors, including the landlords. The court found there was no feasible alternative. The debtors could not operate or conduct going out of business sales. As long as the shelter-in-place and stay at home orders were in place, liquidation efforts would be ineffective and the debtors' assets would be squandered. Deferral of rent payments "presents a short-term allocation of those scarce resources to meet immediate needs and preserve the value of the debtors' estate for all creditor constituencies." The landlords were "merely one group among many that must make concessions in order to benefit all."

Conclusion

As the old saying goes, desperate times call for desperate measures. We are beginning to see a number of extraordinary rulings from bankruptcy courts in response to the crisis caused by the global pandemic. Landlords expect post-petition rent will be paid timely, as provided by the Bankruptcy Code. It is clear that in this case, in the face of a global pandemic that caused "the world to grind to a halt," the court took actions necessary to preserve value for all stakeholders, including the landlords. The question landlords will be asking in the coming months and years is: Does this policy only apply in global pandemics, and if not, when will debtors be able to attempt to rely on the Pier 1 ruling to defer payment of post-petition rent, and for how long? Only time will tell.

Andrew C. Kassner is co-chair of Faegre Drinker Biddle & Reath and a member of the firm's board. He can be reached at andrew.kassner@faegredrinker.com or 215-988-2554.

Joseph N. Argentina Jr. is a senior attorney in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, Delaware, offices. He can be reached at [email protected] or 215-988-2541.