There are generally three types of claims in a bankruptcy proceeding: unsecured claims, secured claims and administrative expense claims. Section 503 of the Bankruptcy Code governs the allowance of administrative expense claims. Section 503 provides that “after notice and a hearing, there shall be allowed administrative expenses…, including the actual and necessary costs and expenses of preserving the estate.” 11 U.S.C. § 503(b)(1)(A). A creditor who seeks to have its claim paid has an administrative claim, and therefore ahead of the general unsecured creditors, bears the burden of establishing that its claims qualifies for priority status. In re New Century TRS Holdings, Inc., et al, 446 B.R. 656, 661 (Bankr. D. Del. 2011). Courts generally apply a two-part test in deciding whether a claim qualifies as an administrative expense: (1) whether the expense arose from a post-petition transaction between the creditor and debtor; and, (2) whether the expense was “actual and necessary” to preserve the estate. Id., citing In re Unidigital, Inc., 262 B.R. 283, 288 (Bankr. D. Del. 2001). Claims which do not constitute an administrative expense are often treated as general unsecured claims which are payable in the ordinary course with other unsecured creditors of the estate. In re Arrow Carrier Corp., 154 B.R. 642, 646 (Bankr. D. N.J. 1993).

Aside from the allowance of an administrative claim, a common issue concerning creditors is the timing of payment of the administrative claim. Although Section 503 of the bankruptcy code provides that an entity can request payment of an administrative expense claim, the section does not address the question of when a claim for administrative expense is to be paid. In re HQ Global Holdings, Inc., 282 B.R. 169 (Bankr. D. Del. 2002) (further citations omitted). The determination of the timing of payment of an administrative expense claim is within the discretion of the bankruptcy court. Id., citing In re Colortex Industries, Inc. 19 3d 1371, 1384 (11th Cir. 1994). In deciding the timing of payment for an administrative expense claim, one of the central factors courts consider is the goal of the bankruptcy court to have an orderly and equal distribution among creditors and a need to prevent a “race to a debtor’s assets.” Id. Distributions to administrative claimants are generally not allowed when the estate may not be able to pay all administrative expenses in full. Id., citing In re Standard Furniture, 3 B.R. 527, 532 (Bankr. S.D. Cal. 1980). Even though courts generally wait until after confirmation before allowing payment on administrative expenses, courts nevertheless have discretion to consider other factors in deciding whether to grant immediate payment. These factors include the particular needs of the administrative claimants, as well as the length and expense of the administration of the bankruptcy proceeding. Id., at 173, citing In re Reams Broadcasting Corp., 153 B.R. 520, 522 (Bankr. N.D. Ohio 1993).

In HQ Global Holdings, the Delaware Bankruptcy Court considered whether commercial landlords of the debtor are entitled to the immediate payment of their administrative rent claims. The court in HQ Global agreed with the debtor “that any decision on the amount and payment of the [administrative rent] must await the debtor’s decision whether to assume or reject leases.” Id. at 175. The court reasoned that if the debtor assumed the landlord’s lease, such assumption would resolve the issue of the landlord’s administrative rent claims. By that, if the debtors assumed the leases, then the debtor would be required to cure any defaults and make all past due rent payments under the lease. Id.

Samsonite Corporation, one of the world’s largest luggage manufacturers, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on September 2, 2009.  According to Samsonite’s Declaration in Support of First Day Motions, the company “does not anticipate that any of its customers or suppliers will be materially affected by this [bankruptcy] filing.”  While this is good news for Samsonite’s customers, the outcome for the company’s landlords is less certain.

As stated in its Declaration, Samsonite leases 173 retail stores in 38 states.  Due to a sudden drop in consumer demand for travel products, Samsonite experienced a significant reduction in its cash flow.  As a result, the company engaged in a restructuring process that culminated in the filing of its bankruptcy petition in Delaware.  Through bankruptcy, Samsonite intends to reject up to 84 leases for those stores the company deems unprofitable.

Landlords dealing with commercial tenants in bankruptcy face a host of issues, including administrative rent, rejection damages and adequate assurance.  A previous post on this blog titled “Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy” provides a good introduction to the issues that confront a landlord when a commercial tenant files for bankruptcy.  Judge Peter J. Walsh, a former Chief Judge of the Delaware Bankruptcy Court, recently issued an opinion in the Sportsman’s Warehouse bankruptcy that provides a very helpful understanding of how bankruptcy courts approach claims for administrative rent and taxes that arise under a lease.  Landlords in Samsonite may find Judge Walsh’s decision particularly relevant as Judge Walsh is also the judge presiding over the Samsonite bankruptcy.

As the economy fluctuates, tenant bankruptcies become a greater risk for commercial landlords. Yet some landlords are not familiar with the rights provided to them under the Bankruptcy Code, nor are they aware of the protections provided to a tenant in bankruptcy. For example, certain lease provisions are unenforceable once a tenant files for bankruptcy. Should a landlord attempt to exercise its rights under the lease without first seeking approval from the bankruptcy court, the landlord may be subject to strong sanctions. The purpose of this article is to provide landlords with the questions and answers they should consider when a commercial tenant files for bankruptcy.

1. What effect does a tenant’s bankruptcy have on the lease?

Once a tenant files for bankruptcy, it has three options regarding the lease: it can assume the lease and continue performing all obligations, or assume and assign the lease to a third party, or reject the lease and surrender the premises and terminate performance. The Bankruptcy Code gives the debtor-tenant 120 days to decide whether to assume or reject the lease. During this period, the tenant can request one 90 day extension to decide what to do with the lease.

If the debtor-tenant fails to assume or reject the lease within the 120 day period, and no extension is granted, the lease is deemed rejected. This is a significant provision for landlords. To be proactive, landlords should review all pleadings filed in the tenant’s bankruptcy proceeding to see if the debtor-tenant sought an extension of time to assume or reject. Additionally, landlords should review the tenant’s motions to assume, motions to assume and assign, as well as motions to reject leases. The exhibits to these motions often contain schedules identifying the leases affected by the motion.

2. How does the “automatic stay” of the Bankruptcy Code apply to landlords?

The automatic stay is one of the most powerful protections provided to debtors in a bankruptcy proceeding. The stay acts as an injunction that prohibits creditors (including landlords) from commencing or continuing any proceeding against the debtor which could have been commenced prior to the bankruptcy. Before a landlord seeks to enforce its rights under the lease (such as through eviction, termination or foreclosure), the landlord should seek “relief” from the automatic stay by filing a motion with the bankruptcy court.

It is important for landlords to realize that the automatic stay becomes effective without notice or a hearing. Were a landlord to be found in violation of the automatic stay, the debtor-tenant may be able to recover actual damages from the landlord, including attorneys’ fees. If the violation is found to be intentional, the debtor-tenant may recover punitive damages.

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