Phillips Nizer LLP Articles

Article - Landlords Can Often Receive Far More in a Bankruptcy Case Than the Phar-Mor Case Would Suggest (Mann Report)

Most landlords have had some experience dealing with a tenant's bankruptcy; but not all know the answer to the important question of when they can expect to be paid currently, and in full, for obligations that arise under a lease after the filing of a tenant's bankruptcy petition?  In re Phar-Mor, Inc., et al., 290 B.R. 319 (Bankr. N.D. Ohio 2003) is a recent case that, rather than answering the question, merely demonstrates how dangerous it is to read one case and think you know the law.

Phar-Mor deals with Section 365(d)(3) of the United States Bankruptcy Code, which provides that a trustee or debtor-in-possession

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…

While there are many obligations under a lease, Phar-Mor deals with the hotly-disputed question of when a debtor-tenant's lease obligation to reimburse its landlord for taxes will be paid in full as a post-petition administrative expense, and when it will be prorated between the pre- and post-petition periods (with a significant portion being paid only pennies on the dollar as a pre-petition claim).  The difference can be dramatic.

To understand why Phar-Mor does not decide the question in other cases, one must understand that bankruptcy judges' decisions do not bind other judges.  (It is the United States Courts of Appeals that bind the lower federal courts in their respective circuits, with the United States Supreme Court acting as the final arbiter.)  And, since Judge Bodoh (the judge who decided the Phar-Mor case) retired from the bench this year, he will not be ruling on such questions in the future.

The Phar-Mor court, and some other courts that have prorated obligations between the pre-and post-petition periods, have found Section 365(d)(3)'s apparently-simple language to be ambiguous, saying that it is unclear whether an "obligation" "arises" as it accrues or when it is due.  Judge Bodoh took the position that the tax reimbursement obligation arose as the tax accrued over time, and citing to lease language authorizing proration in other circumstances, he prorated the taxes between the pre- and post-petition periods (notwithstanding the fact that the payment came due post-petition). 

Although bound by decisions of the Sixth Circuit Court of Appeals (which covers Ohio, Kentucky, Michigan, and Tennessee), Judge Bodoh distinguished Phar-Mor from the recent Sixth Circuit decision in Koenig Sporting Goods, Inc. v. Morse Road Co. (In re Koenig Sporting Goods, Inc.), 203 F.3d 986 (6th Cir. 2000) (which held that a monthly rent obligation due on the first day of the month had to be paid in full, even when the lease was rejected on the second day of the month), by stressing the difference between a single month's rent and the two years of property taxes in Phar-Mor.  The statute, however, does not distinguish among types of lease obligations. 

While Koenig did not deal with tax reimbursement, it remains an open question as to what the Sixth Circuit would do if presented with that issue.  However, three other Courts of Appeals have dealt with non-rent obligations under Section 365(d)(3).  One, the Seventh Circuit (covering Illinois, Indiana and Wisconsin), applied the proration approach to property taxes in In re Handy Andy Home Improvement Centers, Inc., 144 F.3d 1125 (7th Cir. 1998); while in a later case, HA-LO Industries, Inc. v. CenterPoint Properties Trust (In re HA-LO Industries, Inc.), 342 F.3d 794 (7th Cir. 2003), deciding that a monthly rent obligation must be paid in full.

However, the Third Circuit (covering Delaware, New Jersey, Pennsylvania and the Virgin Islands) and the Ninth Circuit (covering Alaska, California, Hawaii, Idaho, Montana, Nevada, Oregon, Washington, Guam and the Northern Mariana Islands) have required payment in full.  In CenterPoint Properties v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 268 F.3d 205 (3rd Cir. 2001), the Third Circuit held that Section 365(d)(3) is not ambiguous, and that all obligations under a lease arise when the debtor-tenant becomes legally obligated to perform them.  If that performance date occurs during the period covered by Section 365(d)(3), the Third Circuit says it "must be fulfilled not in part, but in full."  In Cukierman v. Uecker, et al. (In re Cukierman), 265 F.3d 846 (9th Cir. 2001), the Ninth Circuit went so far as to determine that the obligations required to be paid in full included even the repayment of promissory notes denominated as "further rent" under a lease.

An often critical element of a court's decision is its analysis of the language of the lease.  It is, therefore, extremely important to analyze that language in the context of the developing law, to maximize the chance that a court (even one that may have prorated an obligation when dealing with different language) will determine that payment in full is required.  While not all lease language is equally helpful, until the lease and the applicable law have been properly analyzed, a landlord should not resign itself to having its Section 365(d)(3) lease obligations prorated between the pre- and post-petition periods.