In re Goody’s Family Clothing, Inc - F3d – 2010 WL 2671929 (3d Cir June 29, 2010)

CASE SNAPSHOT

The United States Court of Appeals for the Third Circuit held that the landlords are not precluded from seeking payment of “stub rent.” Debtors often manipulate their bankruptcy filing date so that they can take advantage of existing case law interpreting section 365(d)(3) of the Bankruptcy Code, which holds that rental payments that are “due” prior to the filing of bankruptcy (even if the payment relates to occupancy after the bankruptcy filing) are not obligations that are required to be paid pursuant to the terms of the Bankruptcy Code. Thus, for many “first-day-of-the-month” leases, a debtor will file on a day after the first day of the month, arguing that the rental payment was due pre-petition and therefore the debtor can occupy the premises for the remainder of the month post-petition without the payment of any rent. This period is often referred to as the “stub period.”

FACTUAL BACKGROUND  

Goody’s Family Clothing manipulated its bankruptcy filing in this manner. Goody’s did not pay any rent for the month in which it filed for bankruptcy; however, it commenced paying regular lease payments on the first day of the month immediately following the bankruptcy filing. During the stub period, Goody’s conducted going-out-of-business sales, securing a substantial return on the inventory sold and, in the process, obtained payment from the liquidation agent, for the agent’s occupation of the space during that stub period.

Various landlords argued that they should be entitled to receive compensation for the debtor’s occupation of the space during the stub period. Since the landlords could not seek recovery under section 365(d)(3) of the Bankruptcy Code (the section that governs the landlord’s right to payment), the landlords sought recovery under section 503, the more traditional section of the Bankruptcy Code which governs allowance of administrative claims. The landlords argued that the ongoing occupation of the space during the stub period conferred an “actual necessary benefit on the estate,” and that the expense associated with that occupation should be paid to the landlords. The debtor argued that section 365(d)(3) of the Bankruptcy Code was the exclusive right of recovery for landlords for post-petition occupation, and therefore no payment for the stub period could be made. The Bankruptcy Court granted the landlords’ claims for the amounts due during the stub period and the District Court affirmed. Goody’s took an ultimate appeal to the United States Court of Appeals for the Third Circuit.

COURT ANALYSIS

The Third Circuit began by underscoring its prior holdings that section 365(d)(3) of the Bankruptcy Code provides a mechanism for payment to landlords for the occupation of space during the post-petition period. The court noted, however, that the landlords were not seeking payment pursuant to section 365(d)(3); rather, the landlords were seeking authority under a separate and distinct section of the Bankruptcy Code for the stub period. The court quickly dismissed the debtor’s argument that section 365(d)(3) was the exclusive remedy for post-petition occupation. While section 365(d)(3) references section 503 of the Bankruptcy Code, 365(d)(3) simply excuses a landlord’s obligations to comply with the otherwise extensive evidentiary burdens of section 503 to obtain administrative expense status. The Bankruptcy Code does not make section 365(d)(3) the exclusive avenue for payment, nor does it preempt or supplant section 503. Therefore, a landlord is not prohibited from seeking payment under the “more stringent” section 503 standards.

After holding that a landlord could seek a claim for the stub period under section 503(b)(1), the court went on to explain that, to successfully obtain an administrative claim, the landlord must prove that the occupation of the space conferred an “actual and necessary benefit” to the debtor in the operation of its business. Noting that mere occupancy will not always confer “an actual and necessary benefit” on the estate, the court stated that the debtor here enjoyed a clear benefit beyond mere occupancy. Goody’s conducted substantial going-outof- business sales during the stub period, and collected an occupancy fee from its going-out-of-business sales agent. Therefore, it was clear that the occupation of the space during that stub period resulted in an easily identifiable benefit to Goody’s, both in the conduct of the sales and in the recouping of expenses associated with occupation.

PRACTICAL CONSIDERATIONS

This case confirms the holdings of several lower courts within the Third Judicial Circuit, and confirms that landlords whose rent is not paid for the stub period can seek redress. However, the opportunity to seek redress involves a substantial evidentiary undertaking for the landlord. Often, the “one-month” rent associated with the debtor’s filing manipulation does not justify seeking the increased burden to establish the allowance of a claim under section 503(b)(1) of the Bankruptcy Code; however, where the debtor has so clearly obtained a benefit from the occupation of the space during the stub period, this case confirms the landlord’s entitlement to seek the claim so long as it can meet its requisite evidentiary burden.