Treatment of Stub Rent after Filing for Bankruptcy

May 2011

This post will discuss what is commonly referred to as “stub rent” in the context of Chapter 11 and how bankruptcy courts treat stub rent during bankruptcy proceedings.

Stub rent usually refers to unpaid rent applicable to the period after a retailer files for bankruptcy and before the first date when rent comes due post-petition. For example, if the retailer files for bankruptcy on May 12th, the stub rent period is the period from May 12th to May 31st.

Under Section 365(d)(3) of the Bankruptcy Code, the retailer is required to pay all amounts that come due post-petition under a commercial real estate lease, without the landlord having to first demonstrate that such amounts constitute “actual necessary costs and expenses of preserving the estate” as is required for the payment of an administrative claim under Section 503(b)(1).

Some bankruptcy courts use a “proration” rule that requires the retailer to pay the pro-rated portion of any rent that falls due post-petition, even if the retailer filed in the middle of the month and the rent was due on the 1st of the month.  Other courts follow a “billing date” approach, whereby the obligation arises when it becomes payable under the lease.  If the payment date falls after the petition date, payment is required, but if it falls before the petition date, it is not.  Therefore, under the “billing date” approach, the retailer does not have to pay post-petition stub rent when the petition date falls after the date that the rent is due.  The amount owed simply becomes part of the landlord’s prepetition claim.

Courts within the 3rd Circuit, which includes Delaware where many of the largest retail bankruptcy cases have been filed, generally have used the “billing date” approach and have ruled that the retailer does not have to pay stub rent.  However, in the Goody’s bankruptcy case, the retailer filed for bankruptcy in Delaware in June 2008.  Even though it did not pay the June 1, 2008 rent, Goody’s continued to conduct business from the leased stores during the month of June.  The landlords sought immediate payment of the stub rent as an administrative expense.  The bankruptcy court agreed the stub rent was an administrative expense, but denied the landlord’s request for immediate payment.  The U.S. District Court upheld the bankruptcy court decision ruling that since Goody’s used the stores to conduct GOB sales during June 2008, and Goody’s charged the liquidator it hired a per diem fee for using the stores, the retailer received an actual benefit.  The US Supreme Court declined to consider Goody’s challenge of the lower court ruling.

If you are a retailer considering filing for bankruptcy, it is important to understand how stub rent has historically been treated by the courts in the district where you plan to file. Since retailers typically lease the majority of their stores, a court ruling in favor of the “billing date” approach over the “pro-ration” approach can have a major impact on the cash flows of the retailer early in the bankruptcy process.

Which method do you believe results in the fairest treatment for retailers and their landlords?