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Chicago Bankruptcy Court holds rent may be reduced during Chapter 11 proceedings due to COVID-19 shutdown orders

Lauren Newman June 26, 2020

A Chicago bankruptcy court recently ruled in In re Hitz Restaurant Group that a debtor’s obligation to pay rent during its bankruptcy case may be temporarily reduced because of a force majeure clause in the lease and the governor’s COVID-19 stay-at-home order. Both landlords and tenants should be aware that this rent reduction was carefully crafted and was not unlimited by the court.

Background

Hitz Restaurant Group operated Giglio’s State Street Tavern in Chicago. After the company filed Chapter 11, its landlord moved for relief from the automatic stay because the debtor had not paid rent since March. In the alternative, the landlord requested that the debtor be required to immediately to pay post-petition rent and timely perform all future rent obligations. The landlord based its request on Section 365(d)(3) of the Bankruptcy Code, which requires that a debtor timely perform all post-petition obligations, “under any unexpired lease of nonresidential real property until such lease  is assumed or rejected….”

The debtor argued that the terms of the lease excused the debtor from the obligation to pay rent. In particular, the debtor focused on the lease’s force majeure clause, which excused performance by either the landlord or the tenant “but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by…laws, governmental action or inaction, orders of government…Lack of money shall not be grounds for Force Majeure.”

The court then evaluated whether the governor’s executive order preventing the consumption of food and drink on Illinois restaurants constituted governmental action triggering application of the force majeure clause. The executive order prohibited on premises consumption of food and drink in restaurants. Notably, the Governor’s executive order did not prohibit curbside-pickup and delivery.

Decision

The court concluded that the lease’s force majeure clause applied to the debtor’s request for rent relief. The court noted that interpretation of the force majeure clause was a matter of Illinois state contract law. Under Illinois law, a force majeure clause will only excuse performance if the triggering event is the proximate cause of the party’s non-performance under the contract. The Governor’s stay at home order prohibited on-premises consumption of food and beverages, but allowed for in-house delivery, third party delivery, drive-through and curbside-pickup to purchase food and beverages. Therefore, not all restaurant operations were prohibited.

With that backdrop, the court ruled that the contractual amount of March’s rent was due by the debtor because the rent was due on the first day of the month under the lease and the shutdown order did not go into effect until March 16. However, the court held the debtor was excused from paying the full monthly rent beginning on April 1. The court reasoned, however, that the debtor was obligated to pay 25% of the rent because 75% of the restaurant’s square footage was used for in-person dining and 25% of the premises could be used for curbside pickup and delivery. The court acknowledged that the evidence introduced at the hearing was sparse on this point, but nevertheless based its conclusion on reduced use of the space by the debtor. Since only the kitchen could be in use during this time, the debtor owed 25% of the rent based on the limited use of the space.

The court also explained that as the debtor’s use of the space would increase as governmental restrictions are gradually lifted and rent could be increased as well. Monthly rental payments due after that were likely to increase, as the government’s shutdown restrictions were lifted and the amount of space in the restaurant used by the debtor increased. Finally, since this case came to the court upon a motion for relief from the automatic stay, the court noted that those proceedings are normally summary proceedings and things needed to move quickly. The court required the past-due rental payments to be paid to the landlord within a matter of weeks from the entry of its decision. In addition, the court authorized the reduced payment of 25% of both the common area maintenance fees and real estate taxes for the months of April, May and June as well.

Analysis

This decision illustrates the lengths to which bankruptcy courts have gone to fashion equitable remedies to deal with the unprecedented COVID-19 restrictions. For example, in the bankruptcy case of Pier I Imports, Inc., the debtors filed an emergency motion to stop paying rent while continuing to pay only “critical business expenses” for a short time, due to store closures. Specifically, the debtors in Pier I Imports requested that they not be required to pay rent to certain landlords, but would continue to pay insurance and utilities. The court allowed the extraordinary relief, and deferred some of the rental payments. The court emphasized that, “Covid-19 presents a temporary, unforeseen and unforeseeable glitch in the administration of the Debtors’ Bankruptcy Cases.” The debtors in Pier I Imports not only planned to resume rental payments on reopening of the stores, they planned to cure the default prior to confirmation of a plan. In that regard, Pier I Imports differs from the Hitz case, where the debtor tenant in Hitz was excused from payment 75% of the rent during the shutdown.

Conclusion

While these types of rent abatements or concessions now being allowed by the Bankruptcy Courts certainly assists a tenant’s reorganization efforts, the reduction in rent will certainly affect landlords, many of whom will have mortgage lenders. Mortgage loan defaults by landlords and property owners may follow rent concession orders. Not every property owner is in a position to “carry” its tenants through the Chapter 11 process, and just like tenants, property owners very greatly in size and resources. There may be unintended consequences from the best of intentions. Today’s successful reorganization could be tomorrow’s mortgage foreclosure.

Lauren Newman is a partner in Thompson Coburn’s financial restructuring and bankruptcy practice.

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