by Kevin Lissemore*
Bankruptcy allows financially distressed entities to alter their legal relationships with other parties by providing bankruptcy trustees and debtors in possession with the ability to reject otherwise valid executory contracts or commercial leases.1 This provides bankrupt entities with a unique opportunity to avoid performing in full agreements that may not benefit them in the future. This power can have a significant negative impact on parties who contract with a debtor, because those parties can only receive the expected consideration by filing a claim in the bankruptcy, where they will typically only receive a fraction of the value of that claim upon confirmation of a final bankruptcy plan. As such, the precise extent of the section 365 rejection power has generated significant litigation.
Section 365(d)(3), for example, requires bankruptcy trustees and debtors in possession (the “debtor”) to timely comply with all obligations arising under their lease until the time they choose to assume or reject it.2 The crucial question for creditors and debtors in this situation is exactly what “obligations” arise under their lease agreement and, perhaps more importantly, when a particular obligation is deemed to arise. This determination is particularly significant when a debtor chooses to reject their lease shortly after a rent bill comes due. Since debtors are required to vacate the premises immediately upon rejection,3 they may ultimately pay in full for an entire rental period without actually occupying or using the premises for the entirety of the period.
Debtor-tenants argue that this practice is unfair or against the interest of other creditors. Indeed, some district and bankruptcy courts have found that debtors need only pay in full for the prorated portion of the rental period that accrued before they rejected their lease.4 But each of the federal courts of appeals to have considered this question have interpreted the statute in favor of landlords, and ordered that rent obligations coming due prior to rejection must be paid in full even if the debtor vacates the premises before the end of the rental period.5 This Contribution will argue in favor of the view adopted by these circuit courts, because it is supported by the plain meaning of section 365(d)(3)’s text, the statute’s purpose in the greater context of the Bankruptcy Code, and policy considerations.
11 U.S.C. § 365(d)(3) states that “[t]he trustee6 shall timely perform all the obligations of the debtor . . . arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title.” Two competing interpretations of this statute have emerged: the proration approach, under which the debtor is only required to pay “sums coming due under a lease during the post-petition, pre-rejection period that pertain to benefits realized by the estate during that period,”7 and the performance date approach, which requires that “any amount coming due under a lease in the post-petition, pre-rejection period must be paid in full by the debtor without regard to whether the payment pertains to a pre-petition or post-rejection benefit.”8 For decades, textualism has been the predominant method of statutory interpretation in American jurisprudence.9 And while the performance date approach naturally arises from the plain text of the statute, the proration approach can only rely on extratextual principles for support.
In the context of rent charges, these two interpretations conflict when a debtor opts to reject their commercial lease shortly after the due date for rent. In most leases, rent for the month (or other specified period) is due in full on the first day of the period. Under the performance date approach, since all the rent for the period comes due at once, the debtor would be responsible to pay the entirety of the rent for that period in full, even if they reject the lease and move out shortly after the due date. The proration approach, on the other hand, asserts that a debtor in this situation should only have to pay in full the amount allocable to the proportion of the rental period that passed before they rejected their lease.
Since “obligation” is not defined in the bankruptcy code, section 365(d)(3) presumably uses the word “in its commonly understood sense” relevant to the context.10 Black’s Law Dictionary defines an obligation as “a legal or moral duty” or “a formal, binding agreement or acknowledgement of a liability” to pay or do something, “especially a duty arising by contract.”11 In the context of lease obligations, then, the contract itself is definitive in setting the parties’ obligations thereunder.12 Therefore, when the lease includes a term obligating the tenant to pay rent in full on a specific date, the debtor in possession or bankruptcy trustee must perform that obligation in full if they do not reject their lease before the contractual due date. Indeed, every court of appeals to address this issue has looked to the applicable leases and consequently adopted the performance date approach.13
When the plain meaning of the statutory text is straightforward and results in a reasonable outcome, it must be enforced as written.14 This is not the only support, however, for adopting the performance date approach. Considering the purpose of the statute as part of a broader legislative regime can also illuminate its proper interpretation. Section 365(d)(3) originated in the 1984 amendments to the Bankruptcy Code. Prior to that amendment, lease obligations that arose after a debtor filed its bankruptcy petition, but before it chose to reject its lease, were only addressed under 11 U.S.C. § 503. Section 503(b)(1) provides that creditors may be paid immediately and in full for “the actual, necessary costs and expenses of preserving the estate” during the bankruptcy proceeding.15 Supporters of the proration approach point to section 503’s requirement that these “administrative expenses” be prorated, such that only the amount allocable to the period prior to rejection would be due in full. Based on the general principle that the Bankruptcy Code should not be “read . . . to erode past bankruptcy practice absent a clear indication that Congress intended such a departure,”16 they conclude that obligations under section 365(d)(3) should be prorated in the same way.17
This interpretation is flawed for several reasons. First, it does not comport with the text of section 365(d)(3), which says that the new treatment it prescribes for the category of expenses that fall under its purview will apply “notwithstanding section 503(b)(1).”18 This clause provides the requisite clear indication that Congress intended these expenses to be treated in a new, different way. And, looking beyond the text, “[i]t seems clear . . . that Congress enacted § 365(d)(3) for the purpose of altering a pre-Code practice that had created a problem for landlords of non-residential property . . . .”19 Under section 503, a creditor requesting to be paid an administrative expense for one or more of the debtor’s lease obligations would have to dedicate the time and expense of providing notice and attending a hearing in order to get paid. And even at that hearing, they would only be able to recover the reasonable value of the debtor’s actual use of the premises. Additionally, if the bankruptcy court found that the rent price set in the lease was unreasonable, it could displace the bargain entered into by the parties and instead limit recovery to whatever it deemed to be the fair market value of the premises.20
This treatment was especially problematic for landlords because, unlike other entities that might be contracting with a debtor, a landlord cannot go out and sell the service they were initially providing to the bankruptcy party to a new contractual partner—the debtor is allowed to stay in the premises, immune from eviction,21 while they take up to 300 days to decide whether to assume or reject their lease.22 Thus, the landlord is an involuntary creditor in bankruptcy, forced to allow a debtor to monopolize their property without receiving fair payment in return.23 Congress was certainly cognizant of landlords’ challenging predicament under section 503 when it enacted section 365(d)(3). The purpose of the new legislation was to benefit landlords, by eliminating the need to apply for a hearing and prove that the full amount of their claims is necessary to the preservation of the estate.24 It follows that the other restriction of section 503, such as the proration of administrative expenses, would also be displaced when section 365 became law.25
Even leaving the statutory text and the rest of the Bankruptcy Code aside, the performance date interpretation of section 365(d)(3) is also preferable in terms of its practical outcomes. While critics assert that it displaces the fundamental theme of equal treatment amongst bankruptcy creditors and provides a windfall to commercial landlords,26 the performance date approach merely reflects the common congressional practice of prioritizing certain types of creditors when there is a prudential reason to do so. Moreover, the performance date interpretation of section 365(d)(3) incentivizes landlords to rent to tenants with a higher risk of default, thereby supporting the growth of small and midsize businesses.
One of the foremost objections to the performance date approach is that applying it “often converts what would be prepetition debt (attributable to either pre-order-for-relief occupancy or post-rejection occupancy) into an administrative claim, thereby violating the principle of creditor equality.”27 This argument, however, oversimplifies the Bankruptcy Code—when Congress determines that another value outweighs the general creditor equality axiom, it freely prioritizes certain creditors or expenses over others.28 While proration is a reasonable way to satisfy the claims of similarly situated actors, Congress enacted section 365(d)(3) specifically because commercial landlords are not like other actors, given their status as involuntary creditors precluded from accessing or receiving payment for their property during the pendency of the bankruptcy. Proration is not a panacea, and legislation can and should supplant it when there is a compelling policy reason to do so.
Another commonly alleged flaw of the performance date approach is that it creates a windfall for landlords, allowing them to collect rent allocable to the post-rejection period immediately and in full, while other creditors must wait to be paid until the court approves a final plan.29 However, this criticism ignores the fundamental benefits of the approach and instead emphasizes contingent risks which parties can easily avoid through due diligence. Indeed, without the performance date approach, landlords would actually be subject to greater losses than other creditors.30
First, landlords in this situation do not have the requisite control to effect a windfall gain because the bankrupt party (the trustee or debtor in possession), not the landlord, determines when to reject a lease. The bankrupt party can easily reject at the end of the rent period and thereby avoid any continuing post-rejection expense.31 The performance date approach is also just as likely to work to the benefit of debtors: for example, if rent comes due the day before the debtor files for bankruptcy, and the debtor does not make the payment before filing, the entire rent expense would be treated as a regular pre-petition claim, payable only in part and at the end of the bankruptcy proceeding.32
The performance date approach embodies an eminently sensible view of what Congress intended to achieve in passing section 365(d)(3). Allowing landlords to collect the final period’s rent payment in full once a tenant rejects the lease gives them the chance to maintain financial stability while finding new tenants to replace rejecting debtors. This task takes time, as it is hard to predict when a debtor will choose to reject a lease, and an ongoing global pandemic further complicates the process of releasing. The proration approach, on the other hand, would saddle landlords with higher loss exposure in the event a tenant becomes insolvent and rejects their lease. This would incentivize landlords to rent only to large, highly solvent corporations, and discourage bargaining with small or early-stage businesses that might have a heightened risk of default or bankruptcy. The performance date interpretation of § 365(d)(3) eases the consequences of tenant insolvency for landlords, who are otherwise held in in a state of uncertainty by a tenant who may not be able to pay while they decide whether or not to assume their lease.33
Ultimately, § 365(d)(3) governs situations where one party, debtor or landlord, will inescapably suffer greater consequences than the other. In such a case, the decision of which party deserves precedence is a subjective evaluation much more apt for the people’s representatives in Congress than the judiciary. In passing the language of § 365(d)(3), Congress made this choice in favor of commercial landlords. And while “[o]ne can disagree with this legislative classification as a political matter . . . when language as clear as ‘all the obligations of the debtor . . . under any unexpired lease’ is invoked by a landlord,” a court’s only role is to identify the obligations defined in that lease and enforce them accordingly.34
* Kevin Lissemore is a J.D. Candidate (2023) at New York University School of Law. This piece is a commentary on the problem at the 2022 Duberstein Bankruptcy Moot Court Competition hosted by St. John’s University School of Law. The question presented was whether 11 U.S.C. § 365(d)(3) requires a trustee or debtor in possession to pay rent due prior to the rejection of an unexpired non-residential real property lease but allocable to the period after the effective date of rejection. This contribution presents a pro-landlord interpretation of the disputed provision, advocating for full payment of all the debtor’s obligations which arise prior to the rejection date of a lease, including all rent expenses which come due in this post-petition, pre-rejection period. The views expressed herein do not necessarily reflect the view of the author.
1. 11 U.S.C. §§ 365(a), 365(d) (providing that debtors have at least 60 days from the date they file for bankruptcy to decide whether to assume or reject a contract).
2. 11 U.S.C. § 365(d)(3).
3. 11 U.S.C. § 365(d)(4); see also In re curio Shoppes, Inc., 55 B.R. 148, 153–54 (Bankr. D. Conn. 1985).
4. See, e.g., In re NETtel Corp., 289 B.R. 486, 489 (Bankr. D.D.C. 2002); In re Trak Auto Corp., 277 B.R. 655, 663 (Bankr. E.D. Va. 2002), rev’d on other grounds, 367 F.3d 237 (4th Cir. 2004); In re Ames Dep’t Stores, Inc., 306 B.R. 43, 65 (Bankr. S.D.N.Y. 2004).
5. Burival v. Roehrich (In re Burival), 613 F.3d 810, 812 (8th Cir. 2010) (“This court agrees . . . that § 365(d)(3) is not ambiguous. . . . Rent obligations in such leases must be performed when they arise after filing and before rejection . . .”); HA-LO Indus., Inc. v. Centerpoint Props. Tr., 342 F.3d 794, 798 (7th Cir. 2003) (“Under the prescriptions of § 365(d)(3), HA–LO is required to timely perform all lease obligations that arise after [the petition date], until the lease is rejected.”); Centerpoint Props. v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 268 F.3d 205, 210 (3d Cir. 2001) (“[F]inding a straightforward interpretation that produces a rational result and no other reasonable interpretation consistent with the text, we are constrained to hold that § 365(d)(3) is not ambiguous.”); Koenig Sporting Goods, Inc. v. Morse Road Co. (In re Koenig Sporting Goods, Inc.), 203 F.3d 986, 989 (6th Cir. 2000) (“The specific obligation to pay rent . . . arose . . . during the postpetition, prerejection period. Under these circumstances, § 365(d)(3) is unambiguous as to the debtor’s rent obligation and requires payment of the full month’s rent.”).
6. This section also extends to Chapter 11 debtors in possession under 11 U.S.C. § 1107(a).
7. Koenig Sporting Goods, Inc. v. Morse Road Co. (In re Koenig Sporting Goods, Inc.), 229 B.R. 388, 391 (B.A.P. 6th Cir. 1999), aff’d, 203 F.3d 986 (6th Cir. 2000); see also In re Ames Dep’t Stores, 306 B.R. at 65 (applying the proration interpretation).
8. In re Comdisco, Inc., 272 B.R. 671, 674–76 (Bankr. N.D. Ill. 2002); see also Koenig Sporting Goods, 229 B.R. at 390.
9. See Rubin v. United States, 449 U.S. 424, 430 (1981) (“When we find the terms of a statute unambiguous, judicial inquiry is complete, except in rare and exceptional circumstances.” (internal quotation marks omitted)); Bostock v. Clayton County, 140 S. Ct. 1731, 1737 (2020) (“When the express terms of a statute give us one answer and extratextual considerations suggest another, it’s no contest. Only the written word is the law. . . .”); See also Harvard Law School, The 2015 Scalia Lecture | A Dialogue with Justice Elena Kagan on the Reading of Statutes, YouTube at 08:28 (Nov. 25, 2015), https://youtu.be/dpEtszFT0Tg (“We’re all textualists now.”).
10. In re Montgomery Ward Holding Corp., 268 F.3d at 209.
11. Obligation, Black’s Law Dictionary (11th ed. 2019) (emphasis added).
12. In re Montgomery Ward Holding Corp., 268 F.3d at 209 (“[A]ny interpretation [of § 365(d)(3)] must look to the terms of the lease to determine both the nature of the ‘obligation’ and when it ‘arises.’”).
13. See supra note 6.
14. See Lamie v. United States Tr., 540 U.S. 526, 528 (2004) (“[W]hen the statute’s language is plain, the sole function of the courts—at least where the disposition required by the text is not absurd—is to enforce it according to its terms.”) (quoting Hartford Underwriters Ins. Co. v. Union Planters Bank, N. A., 530 U.S. 1, 6, (2000)).
15. 11 U.S.C. § 503(b)(1).
16. Cohen v. De La Cruz, 523 U.S. 213, 221 (1998) (internal quotations and citations omitted).
17. See Child World, Inc. v. The Campbell/Mass. Tr. (In re Child World, Inc.), 161 B.R. 571, 575–76 (S.D.N.Y. 1993).
18. 11 U.S.C. § 365(d)(3).
19. In re Montgomery Ward Holding Corp., 268 F.3d at 211
20. Joshua Fruchter, To Bind or Not to Bind—Bankruptcy Code § 365(d)(3): Statutory Minefield, 68 Am. Bankr. L.J. 437, 438.
21. 11 U.S.C. § 362(a)(3) (staying proceedings, including evictions, involving the debtor until the confirmation of a final bankruptcy plan).
22. 11 U.S.C. § 365(d)(4) (providing 210 days, plus a 90-day extension upon motion to the court, for a trustee or debtor in possession to decide whether or not to reject their lease).
23. See HA-LO Indus., 342 F.3d at 799 (“[L]andlords, unlike other creditors, are ‘forced to deal with [their] bankrupt tenant[s] on whatever terms the bankruptcy court impose[s]’ because landlords cannot evict their tenant.” (quoting In re Handy Andy Home Improvement Ctrs., Inc., 144 F.3d 1125, 1128 (7th Cir. 1998))).
24. See H.R. Conf. Rep. No. 98–882, at 598–99, reprinted in 1984 U.S.C.C.A.N. 576, 598–99 (statement of Sen. Hatch, Sen. conferee on bill) (noting that involuntary creditor landlords are “forced to provide current services . . . without current payment. No other debtor is put in this position. . . . This bill would lessen these problems by requiring the trustee to perform all the obligations of the debtor at the time required in the lease[,]” rather than after conducting an administrative expense hearing under section 503(b)).
25. See In re Krystal Co., 194 B.R. 161, 164 (Bankr. E.D. Tenn. 1996) (adopting the performance date approach and holding “Congress intended § 365(d)(3) to shift the burden of indecision to the debtor . . ., a sensible adjustment of this particular debtor-creditor relationship.”).
26. See, e.g., Victoria Kothari, 11 U.S.C. § 365(D)(3): A Conceptual Status Argument for Proration, 13 Am. Bankr. Inst. L. Rev. 297, 321, 348 (2005) (“Obligations of the landlord that arose pre-petition should be classified and treated in the same manner as any other pre-petition creditor.”).
27. In re NETtel Corp., 289 B.R. 486, 492–93 (Bankr. D.D.C. 2002); see also Howard Delivery Serv., Inc. v. Zurich American Ins. Co., 547 U.S. 651, 655 (2006) (“[W]e are mindful that the Bankruptcy Code aims, in the main, to secure equal distribution among creditors.”).
28. See, e.g., 11 U.S.C. § 507 (organizing a range of claims into categories, each with a different level of priority in receiving distribution from the bankruptcy estate); 11 U.S.C. § 1110 (allowing lessors of large aircraft or vessels to reclaim possession of their leased property from the debtor earlier than other lessors).
29. See In re Ames Dep’t Stores, 306 B.R. at 69–70.
30. See supra notes 24–25 and accompanying text.
31. In re Koenig Sporting Goods, 203 F.3d at 989.
32. See In re The 1/2 Off Card Shop, Inc., No. 00–48425-WS, 2001 WL 1822419, at *3 (Bankr. E.D. Mich. Mar. 7, 2001).
33. HA-LO Indus., 342 F.3d at 799.
34. In re Geonex Corp., 258 B.R. 336, 342 (Bankr. D. Md. 2001) (quoting 11 U.S.C. § 365(d)(3)).