On December 18, 2008, in connection with the bankruptcy of the Steve & Barry’s retail chain, the United States Bankruptcy Court for the Southern District of New York held that under Section 365(d)(3) of the U.S. Bankruptcy Code (the “Code”), landlords are entitled to pro-rata postpetition rental payments for the monthly “stub” period following the filing of the debtor-tenant’s bankruptcy petition provided that the debtor-tenant continues to enjoy the right to use and occupy the leased property. See generally, In Re Stone Barn Manhattan LLC, f/k/a Steve & Barry’s LLC, et al., 2008 Bankr. Lexis 3260 (Bankr. S.D.N.Y.).

At issue in In Re Stone Barn was whether, under the Code, debtors are liable, on a post-petition basis, for monthly “stub rent”—that is, the portion of monthly rent attributable to the period that begins on the day the order for bankruptcy relief was first entered and expires at the end of that month—or whether, because the monthly rental obligation accrued in full on the first of the month (prior to the bankruptcy filing), the entire monthly rental obligation was pre-petition and therefore subject to rejection by the debtor under the Code.

Although the Court stayed its decision pending appeal, the Court rejected the argument that monthly stub rent was an unsecured pre-petition obligation and instead held that even if the lease calls for the full payment of monthly rent in advance, that payment will be prorated between the pre-petition and post-petition periods under the Code.

In 1984, Congress amended the Code to provide additional protection to landlords for rent payable after a tenant’s bankruptcy filing. The Court noted that its favoring of the proration method balances the 1984 amendment’s goal of providing protection to landlords for postpetition rent with the overall purpose of the Code. In addition, the Court noted that proration is relatively simple to apply, and is equitable and consistent with typical interpretative practices.

Central to the Court’s ruling was that the proration method could carry out the intent of Congress without eroding the Chapter 11 process, whereas a billing date method would be in direct conflict with the plain purposes of the 1984 amendments to the Code. Prior to In Re Stone Barn, several court rulings on similar issues favored a “billing date” theory and created a situation where the debtortenant could choose the date that it filed for bankruptcy and rejected the lease in order to stay in possession and perhaps avoid another month’s rent. In such instances, the entire monthly rental obligation would be deemed a pre-petition claim and the debtortenant would have the right to use the premises for almost an entire month, possibly without incurring any rent liability for that period.

In order to obtain any rent for the stub period, a landlord would be required to file a motion and prove a benefit to the debtor from the occupancy of the leased premises, after a notice and a hearing.

Ultimately, the Stone Barn Court held the debtors responsible, on a post-petition basis, for rent as it accrues, measured on a daily basis, after the date of the order for relief until the end of that month.

Debtor-tenants will need to carefully consider the dates on which they file an order for relief, and reject leases and executory contracts in light of the holding in In Re Stone Barn. Unless the In Re Stone Barn Court is overruled on appeal, debtor-tenants should consider filing later in the month since the days remaining after the filing will be prorated and the trustee will be obligated to pay prorated rent for the post-petition days in that month. However, if the Court’s favoring of the proration method is overruled, debtors should consider filing for bankruptcy earlier in the month, given that the entire month’s rent will be deemed an unsecured pre-petition obligation.

Landlords need to carefully monitor the outcome of the appeal in order to stay apprised of their rights to rental claims under the Code.