In our latest installment of our series “Bankruptcy On Ice”, we tackle temporary suspension of bankruptcy proceedings in response to the closure of “non-essential businesses” and other critical protective measures being imposed to fight the spread of COVID-19. Last week, key decisions in the Pier 1 and Modell’s Sporting Goods bankruptcy cases extended temporary freezes and limited suspensions of proceedings as most states slowly begin to reopen.

Before we get to that, it is important to note that despite the entry of suspension orders freezing certain proceedings in a number of retail and restaurant bankruptcy cases, bankruptcy courts remain open for business across the country. They have not shut down, deadlines have not been extended ad infinitum, and interested parties must stay alert that all critical deadlines are met. And even in these bankruptcy cases now on ice, the courts have emphasized that their doors remain open to parties seeking relief due to exigent circumstances.

No Spring Thaw for Pier 1 and Modell’s Cases (or Their Landlords)

At an April 28, 2020 status conference in the Pier 1 bankruptcy cases (pending in the U.S. Bankruptcy Court for the Eastern District of Virginia), the court addressed Pier 1’s request to continue the COVID-19-related suspension order entered on April 6, 2020. Following the hearing, the court entered a supplemental order extending the debtors “limited operations period” and deferring payments to landlords, suppliers and shippers through May 31, 2020, with the goal of giving Pier 1 a better chance at restructuring once the impacts from the global pandemic begin (hopefully) to lessen.

Typically, section 365(d)(3) of the Bankruptcy Code allows a debtor (like Pier 1 here) to defer rent for only 60 days after the case files. Prior to the hearing, several landlords vigorously objected to the deferral of Pier 1’s obligation to pay rent beyond the 60-day period, arguing that the landlords would not be adequately protected if rent payments were deferred indefinitely, without assurance that they will ever be paid. Pier 1 argued that “no revenue” means “no rent,” and that, practically speaking, Pier 1 simply lacks the ability to pay.

In response to these arguments, the court noted that these are “unforeseen” and “incredible” times, and further explained that Pier 1 “has mapped a clear path forward” by announcing its plans to resume its brick-and-mortar operations if enough states allow it to reopen at least half of its 540 stores. Focusing on that reopening plan, and the fact that Pier 1 doesn’t have the ability to meet its ongoing rent obligations, the court, over landlord objections, extended the limited operations period, deferring the rent obligation to landlords beyond the deadline set forth in section 365(d)(3). Because Pier 1 intended to make “catch-up” payments to their landlords over time, and would continue to make insurance, security, and other critical payments, the court found that there was no need for Pier 1 to make adequate protection payments to landlords. The court is holding a status hearing on May 21, 2020, at which time Pier 1 will report whether it will resume operations on June 1, 2020.

Similarly, at the end of April 2020, chapter 11 debtor Modell’s Sporting Goods, Inc. asked the U.S. Bankruptcy Court for the District of New Jersey to extend the temporary suspension of its bankruptcy case through the end of May 2020. Similar to Pier 1, the Modell’s court addressed whether to permit the debtor to defer the payment of rent beyond the 60-day deadline imposed by section 365(d)(3).

On March 27, 2020, in the height of the COVID-19 shut-downs, Modell’s obtained court approval to halt rent payments to landlords and other expenses when store closures effectively froze all going-out-of-business sales. In response to Modell’s motion to extend its rent payment holiday, a flood of landlord objections echoed the arguments that had been made by Pier 1’s landlords. In response, Modell’s reiterated that rent deferral is warranted under the Bankruptcy Code, notwithstanding section 365(d)(3). Further, Modell’s argued that it is entitled to rent deferral—and possibly even rent abatement—under various state law theories.

Careful to rely on the Bankruptcy Code and avoid state law concepts (which the court explicitly said did not inform its decision), the court agreed to defer rent through May 31, 2020. The Modell’s court, like the Pier 1 court before it, focused on the unique and extraordinary circumstances the pandemic has created for liquidation sales.

The Modell’s court’s ruling highlighted several notable points. First, recognizing the many disputes developing between Modell’s, their lenders, the unsecured creditors’ committee, and the landlords—including what Modell’s obligations are under its leases—the court ordered the parties to mediation as soon as possible to try to work out a practical business resolution. Second, the court explained that it was not inclined to allow the bankruptcy case to be financed on the backs of the landlords; the court stated that it would fashion the appropriate remedy at the appropriate time, and that remedy “won’t be that landlords get zero.” Third, if urgent circumstances arise—such as if a landlord has a tenant ready to take over a space on July 1, 2020—the court is open to a landlord’s request for relief.

More Lurking Icebergs

While retail stores and restaurants remain closed in many states, a gradual reopening of non-essential businesses appears imminent. Meanwhile, though, business has not warmed up enough for bankruptcy courts to unfreeze certain proceedings, including the payment of rent. And even with the relaxed social distancing to come, it is unlikely that retail and restaurant businesses, among others, will be able to return to normal any time soon.

Already, relatively new chapter 11 debtors are following in the footsteps of Pier 1 and Modell’s. FoodFirst Global Restaurants (which filed on April 10 in the Bankruptcy Court for the Middle District of Florida) and J. Crew (which filed on May 4 in the Bankruptcy Court for the Eastern District of Virginia) have sought to suspend, for 60 days from the petition date, their obligations to pay rent while stores remain closed. These debtors may eventually be forced to seek further deferrals of rent payments if store closures and depressed sales numbers continue into the summer months.

This rent freeze trend may continue for to-be-filed bankruptcies if stores remain closed, or if those stores cannot hold appropriate going-out-of-business or other sales. If this happens, we may be in for a frozen summer with other bankruptcy courts granting similar extensions where revenues cannot support rent payments and reorganization efforts are thwarted by the pandemic.

The Battle Between Landlords and Debtors Has Only Just Begun.

During these unprecedented times, burdens have been foisted upon the shoulders of landlords, who still have no idea when their tenants in bankruptcy will be in a position to resume the payment of rent. The landlords still have obligations to pay their mortgages and other expenses. Compounding this stress are tenants outside of bankruptcy that have asked to defer or abate rent due to the impact of the global pandemic.

Unfortunately, many questions remain unanswered. Will deferred rent ultimately be paid after bankruptcy proceedings are thawed? Or will tenants seek further abatement of rent obligations under novel state-law theories? Will landlords continue to fight back against these tenant requests by articulating remedies that are available even in the midst of the pandemic?

As always, regardless of which side of the fight you are on, seek competent counsel to help you adjust the temperature in your favor.

To sign up for email updates from the NextGen Financial Services Report, Click Here.

Stay ahead of emerging issues with Dykema’s COVID-19 Legal Resource Center and subscribe to all relevant publications so you can easily leverage information, stay up to date on evolving developments, and better position yourself for success.