Can a bankruptcy court order rent abatement due to a pandemic? One (sympathetic) bankruptcy court says "No"

Can a bankruptcy court order rent abatement due to a pandemic?  One (sympathetic) bankruptcy court says "No"

Pandemic-related case law of all stripes continues to work its way through the country’s federal and state court systems. Of interest to the franchise community or any business with a leased location is a recent bankruptcy court decision out of Houston, Texas. A judge sided with a group of landlords by denying a bankruptcy company’s motion seeking to abate rent for locations affected by government shutdown orders, finding that neither the Bankruptcy Code, the force majeure clauses of the leases, nor the doctrine of frustration supported the requested relief. 

CEC Entertainment, Inc. and its affiliates - better known as children’s entertainment stalwart, “Chuck E. Cheese” - filed Chapter 11 bankruptcy on June 24, in the United States Bankruptcy Court for the Southern District of Texas, styled as In re CEC Entertainment Inc., Case No. 20-33163. The bankruptcy filing was driven by the COVID-19 pandemic and the resulting measures taken by state and local governments to limit social gatherings. Those regulations impacted CEC’s business by: (1) Prohibiting the operation of gaming and arcade establishments, (2) Restricting the capacity of in-person dining and (3) prohibiting large group gatherings. Given CEC’s business model, those regulations were crushing to the company’s cash flow and its ability to meet its obligations to pay rent.

On August 3, CEC filed the Motion for Order Authorizing Debtors to Abate Rent Payments at Stores Affected by Government Regulations (the “Abatement Motion”), in which CEC requested that the Court enter “an order abating rent payments for stores closed or otherwise limited in operations as a result of any governmental order or restriction until such restriction or order has been lifted….”  The Abatement Motion originally sought relief for 141 CEC venues located across 12 states. CEC reached negotiated resolutions with most of its landlords. However, landlords in six locations spread through Washington, North Carolina, and California held out and objected to the Abatement Motion.  While the Court expressed sympathy for hardships placed on CEC’s business by the global pandemic, it denied the Abatement Motion finding none of the following arguments compelling. 

First, CEC argued that sections 365(d)(3) and 105(a) of the Bankruptcy Code give a bankruptcy court equitable power to alter rent obligations. The Court disagreed, finding that the plain language of section 365(d) of Bankruptcy Code provides only that a bankruptcy court only may extend, for cause, the time for performance of any such obligation that arises under a lease for 60 days from the date of the bankruptcy filing, and that the statute did not permit such time for performance to be extended beyond such 60-day period.  The Court also noted that bankruptcy law requires that a bankrupt lessee of nonresidential real property must timely fulfill its obligations under the lease during the bankruptcy case. As such, the Court noted that it could not override this statutory mandate; nor could it grant the Abatement Motion unless the lease terms themselves or state law otherwise excused CEC’s performance.

Second, CEC argued that the global pandemic and related government regulations were “force majeure” events (provisions specified in a lease that describe acts that create a contractual impossibility) which allowed CEC to delay contractual performance under its leases. The Court reviewed each of the leases at issue (in conjunction with the government regulations/executive orders in place in California, Washington and North Carolina) and determined that the express language in each lease prohibited CEC from delaying its rent obligations on account of a force majeure event because such force majeure clauses were not directly applicable to CEC’s inability to pay rent or its failure to perform due to a lack of funds.

Finally, CEC argued that the doctrine of “frustration of purpose” relieved CEC’s obligation to timely pay rent. While slightly different under each state’s law, the “frustration of purpose” doctrine excuses a party’s nonperformance when circumstances beyond the parties’ control frustrate the purpose of the deal. Generally, in those instances, the remedy is rescission of the contract. Unlike the force majeure clauses, however, “frustration of purpose” relates to the underlying purpose of a contract, as opposed to a party’s actual inability to perform. CEC argued that the global pandemic and related government regulations entirely frustrate the purpose of its leases, claiming that the principal purpose of leases was to operate a family entertainment center (which included traditional restaurant services along with gaming and entertainment). The Court reviewed frustration of purpose laws in California, Washington and North Carolina and concluded that the force majeure clauses in each of the leases superseded the “frustration of purpose” doctrine because the parties were permitted to allocate the risk of unusual governmental regulation in the leases -- instance all to CEC.  The Court found that the parties specifically agreed in the leases that unusual government regulations would not relieve CEC’s obligation to pay rent.

This Court is not the first one to touch on this thorny area of bankruptcy law. Earlier in the pandemic, the Bankruptcy Court for the Eastern District of Virginia found there was a statutory basis in bankruptcy for deferring rent temporarily during the pandemic. In re Pier 1 Imports, Inc., Case No 20-30805. However, in that case, the judge was careful to say that he “did not find that the debtors do not have to pay rent,” nor did he decide that performance was excused by “impossibility, impracticability, or frustration of purpose.” Here, the Court’s opinion finding that neither the Bankruptcy Code nor state law permits reducing rent when government regulations restrict a debtor’s ability to generate income clearly rule on those issues – to the detriment of a struggling business tenants. It remains to be seen whether bankruptcy courts elsewhere in the county who address this issue will take a similar view.

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