The United States District Court for the District of Delaware has held that a landlord could seek payment for the debtor's ongoing use and occupation of leased premises, after the petition date but before the next "scheduled" rental payment date. The court concluded the landlord could seek administrative priority treatment for claims covering this "stub" period, in addition to the mandatory monthly payment rights specified by the Bankruptcy Code. See Goody's Family Clothing, Inc. v. Mountaineer Prop. Co. II, LLC (In re Goody's Family Clothing, Inc.), 401 B.R. 656 (D. Del. 2009).

The facts giving rise to Goody's are not unlike many routine commercial bankruptcy cases involving retail establishments. Goody's Family Clothing, Inc. (the "Debtor") was an apparel retailer that operated 350 stores nationwide. On June 9, 2008, the Debtor commenced a bankruptcy case. After commencement of the case, the Debtor remained in possession of its various leasehold interests through the remainder of the month of June.

In accordance with the requirements of section 365(d)(3) of the Bankruptcy Code, the Debtor commenced regular monthly payments on each of its leasehold interests on the next payment due date (primarily, the first day of each month), July 1, 2009. After demands made by certain landlords for payment of rent associated with the Debtor's use and occupancy of the locations between the Petition Date and June 30, 2008, various landlords filed applications seeking allowance of administrative claims with the Bankruptcy Court.

Rather than seeking to compel payments under section 365(d)(3) of the Bankruptcy Code, the landlords sought to compel payments pursuant to section 503(b)(1) of the Bankruptcy Code. The Bankruptcy Code ultimately allowed the landlords' claims pursuant to section 503(b)(1) of the Bankruptcy Code over the Debtor's objection. The Debtor appealed.

Landlord's Rights Expanded

In the district court, the Debtor argued that because section 365(d)(3) of the Bankruptcy Code provided a specific mechanism for payment of rent to landlords under the statutory scheme, the landlord's right to payment on account of rent was limited to those specific provisions.

The landlords countered that while section 365(d)(3) of the Bankruptcy Code provided a mechanism for payment of rent in accordance with the terms in the lease as and when due (in accordance with the "billing date" approach endorsed by the United States Court of Appeals for the Third Circuit), landlords nonetheless could seek compensation for the use and occupancy of its space for the time prior to the date to commence monthly payments in accordance with section 365(d)(3) of the Bankruptcy Code.

The district court analyzed the structure and scheme of the Bankruptcy Code. The court noted that prior to the 1984 amendments which inserted section 365(d)(3) into the Bankruptcy Code, landlords generally were required to prove their right to recover against for a debtor's use and occupancy of certain leased space pursuant to section 503(b)(1) of the Bankruptcy Code. To establish a right to payment pursuant to section 503(b)(1), a landlord must establish that it afforded an actual benefit to the estate, and that the costs and expenses are necessary to preserve value to estate assets.

The court noted that the 1984 amendments were meant to "ease" a landlord's burden to establish a right to payment. The court determined that nothing in the statutory scheme suggests that section 365(d)(3) of the Bankruptcy Code is the exclusive mechanism for recovery of rent. In fact, the two sections of the Bankruptcy Code relied upon by the parties (i.e., sections 365(d)(3) and 503(b)(1)) are not mutually exclusive. Except for the introductory word "notwithstanding" in the beginning of section 365(d)(3) of the Bankruptcy Code, the sections do not otherwise reference one another.

According to the court, section 365(d)(3) of the Bankruptcy Code was meant to insure that landlords would not be required to establish actual benefit conferred on an estate by the ongoing use and occupancy during continuation of a bankruptcy case. Although section 365(d)(3) of the Bankruptcy Code was a mechanism for recovery, nothing prevented the landlord from also seeking recovery under section 503(b)(1). Here, the court noted that the Debtor remained in the location and conducted going-out-of-business sales generating substantial revenue for the Debtor's ongoing operations. Therefore, the actual benefit conferred (compared with the minimal expense incurred) justified the allowance sought by the landlords.

In affirming the bankruptcy court, the district court concluded that the landlords were able to establish that the Debtor's use and occupancy provided actual benefit to the Debtor's estate and was a necessary expense to preserving estate's assets. Therefore, the court concluded allowance of an administrative claim pursuant to section 503(b)(1) of the Bankruptcy Code was authorized.

Welcome Support

This case is welcome support for landlords in their attempts to collect the Debtor's use and occupancy during various "stub" periods. Many practitioners have asserted that the federal circuit in which a bankruptcy case is pending will determine whether or not a landlord may be entitled to collect on account of certain stub rent obligations. This case makes clear that section 503(b)(1) of the Bankruptcy Code provides a recovery avenue for landlords in addition to the mandatory statutory scheme of section 365(d)(3).

But an additional avenue of recovery does not necessarily mean more money in a landlord's pocket.

One concern is that recovery under section 503(b)(1) requires a more exacting showing and is not limited to the "contract rate" of the lease. Although in Goody's the court allowed a claim for the "stub" rent, the costs associated with pursuit of an allowed claim pursuant to section 503(b)(1) of the Bankruptcy Code (under its more exacting standards) may not be justifiable in other circumstances in light of the requirement to show the amount of benefit the landlord conferred.

A second issue to note is that the simple allowance of a claim pursuant to section 503(b)(1) does not ensure payment. Courts retain discretion to determine the ultimate timing of payments on allowed claims and generally (with limited exceptions) will not require payment of administrative expense claims until a plan of reorganization is confirmed in a debtor's overall bankruptcy case.