March 2021: Bankruptcy & Restructuring Litigation

Bankruptcy Courts’ Willingness To Apply Rarely-Invoked Force Majeure Clauses During Pandemic Enhances Debtors’ Restructuring Options for Non-Residential Real Property Leases

The COVID-19 pandemic and resulting shutdown orders have ignited litigation over a type of contract clause that was previously invoked infrequently, even in bankruptcy court: force majeure.  A force majeure clause “excuses performance of contractual obligations—either wholly or for the duration of the force majeure—upon the occurrence of a covered event which is beyond the control of either party to the contract.” In re Flying Cow Ranch HC, LLC, 2018 WL 7500475, at *2 (Bankr. S.D. Fla. June 22, 2018).

Closures and capacity restrictions imposed on movie theaters, restaurants, and other venues have left operators in a difficult position: how could they pay rent if they could not generate revenue?  Even in a chapter 11 case, section 365(d)(3) of the Bankruptcy Code requires debtors leasing non-residential real property to timely perform their obligations, including the payment of rent in full, unless and until the lease is rejected.  Although section 365(d)(3) allows the bankruptcy court to suspend these obligations upon a chapter 11 filing for sixty (60) days—which courts have done liberally—when the 60 days have elapsed, the obligation to pay rent resumes.  

Enter force majeure—which provides debtors a basis to argue that as a contractual matter performance is excused and a rent abatement is required.  As the three cases discussed below illustrate, bankruptcy courts have ordered a wide range of relief invoking force majeure clauses contained in non-residential real property leases in the past year, including rent abatement in whole or in part.  But if there is one unifying theme, it is that however sympathetic these debtors’ cases may be, force majeure clauses will be construed like any other bargained-for contract terms.  And common-law doctrines such as commercial impossibility or frustration of purpose will not supply an alternative basis for relief when the parties have contractually allocated these risks through a force majeure clause in their non-residential real-property lease.

In re Cinemex

The court in In re Cinemex, Case No. 20-14695-LMI, ECF 100 (Bankr. S.D. Fla. Jan. 27, 2021), held that a lease’s force majeure clause allowed for a full rent abatement during  a government shutdown.  The debtors operated luxury movie theaters with attached restaurants and bars.  As a result of various state government orders designed to curb the spread of COVID-19, the debtors were forced to shut down operations and lay off nearly all of their employees.  Shortly thereafter, the debtors filed for chapter 11 protection in the Southern District of Florida.

The debtors secured a 60-day extension under section 365(d)(3) and successfully negotiated lease amendments with many of the lessors, but not all of them.  After the 60-day extension lapsed, the debtors filed a motion to abate rent and escrowed the disputed amounts pending a resolution of the motion and ongoing lease negotiations.  One lessor moved under section 365(d)(3) to compel the payment of rent.

At a hearing on the motion to compel, the debtors argued the lease’s force majeure clause excused payment of rent while movie theaters were closed by order of the State of Florida.  The court agreed, holding that the lease excused performance when a failure to perform resulted from “acts of God [or] governmental action.”  The court rejected the lessor’s argument that a carveout to a separate clause of the lease—which excused performance under circumstances “beyond the reasonable control of the party obligated to perform (other than failure to timely pay monies required to be paid under this Lease)”—somehow meant the obligation to pay rent was not excused when governmental action prevented performance under the contract.  The court held that the carveout modified only the discrete clause to which it was confined—and not the force majeure clause.

The court found additional support for its conclusion in another clause of the lease stating that if performance was “delayed by reason of ‘Force Majeure,’” including “acts of God” and “governmental restrictions,” the “period for the commencement or completion thereof shall be extended for a period equal to such delay.”  Appling this clause, the court abated rent for the duration of the shutdown and extended the term of the lease by the length of the abatement period.  Between the initial section 365(d)(3) 60-day suspension and the relief granted under the court’s order, the debtors obtained an almost six-month rent abatement.

After the shutdown, the debtors were able to open at 50% capacity with stringent sanitation and PPE requirements.  With respect to this post shut-down period, however, the court declined to grant any relief.  Concluding that performance was not impossible but instead merely “impracticable,” the court held that neither the force majeure clause nor Florida’s law on frustration of purpose supported partial relief.  Noting that under Florida law, “courts are reluctant to excuse performance that is not impossible but merely inconvenient, profitless, and expensive to the lessor,” the court concluded that the debtors’ choice not to reopen for “primarily economic concerns” did not provide a sufficient basis for relief.

Hitz Restaurant Group

The court in In re Hitz Restaurant Group, 616 B.R. 374 (Bankr. N.D. Ill. 2020), applying a differently worded force majeure clause, found a partial rent abatement was appropriate during a shutdown that partially prevented performance.  In Hitz, a restaurant group filed for chapter 11 protection after the state of Illinois shut down indoor dining for a prolonged period but permitted takeout and delivery.  One lessor moved under section 365(d)(3) to compel payment of rent in full.  The debtor opposed, citing the lease’s force majeure clause, under which performance was excused where “prevented or delayed, retarded or hindered by . . . laws, governmental action or inaction, [or] orders of government.”  As in Cinemex, the lessor urged that the failure to pay rent could not be excused because a separate, subsequent clause provided that “Lack of money shall not be grounds for Force Majeure.”  The court ruled for the debtor, excusing the payment of rent because the government orders restricting in-person dining were the “proximate cause” of the force majeure.

The court also held, however, that the debtor’s rent could be abated only to the extent the government orders prevented performance.  The debtors estimated that 75% of the restaurant’s square footage was rendered unusable by the indoor-dining ban.  But the remaining 25% could be devoted to takeout and delivery activities.  Accordingly, the court ordered the debtor to pay 25% of its rent obligation, indicating the percentage could increase if government restrictions lifted.

In re CEC Entertainment

The court in In re CEC Entertainment, 2020 WL 7356380 (Bankr. S.D. Tex. Dec. 14, 2020), denied the debtor’s request for complete rent abatement.  However, the leases arguably contained stricter force majeure terms than those in Cinemex and Hitz.  CEC operated Chuck E. Cheese, a nationwide chain of venues providing arcade entertainment and dining services that catered mainly to children’s parties.  After government orders across multiple states restricted in-person dining, banned large-group gatherings, and prohibited the operation of gaming and arcade establishments, CEC made a business decision to close its stores in lieu of offering limited dining services without the arcade experience for which Chuck E. Cheese was primarily known.

After CEC filed for bankruptcy and requested rent abatement relief, most lessors settled their objections. Six lessor persisted successfully.  The court rejected the debtor’s argument that section 365(d)(3) gave the court discretion to suspend rent obligations beyond the 60 days, finding instead the court’s equitable powers do not authorize it to “override that statutory mandate.”  (The court observed, however, that should CEC refuse to comply with the mandate, the remedy for such violation was not prescribed by statute and might implicate the court’s equitable powers.)

The court also concluded the leases’ force majeure clauses did not provide a contractual basis for rent abatement.  One lease contained an anti-force majeure clause:

This Lease and the obligations of either party hereunder shall not be affected or impaired because either party is unable to fulfill any of its obligations hereunder or is delayed in doing so, if such inability or delay is caused by reasons of strike, labor troubles, acts of God, or any other cause beyond the reasonable control of either party.

Another lease specified that the types of performance excused under its force majeure clause did not include “Tenant’s obligation to pay, when due and payable, the rents, charges or other sums reserved hereunder.”  The rest of the leases specified that excuse of performance due to force majeure “shall not apply to the inability to pay any sum of money due hereafter.”  

Finally, the court considered and rejected “frustration of purpose” as a basis for relief because the parties’ bargained-for force majeure clause “supplanted” the common law and “delegate the risk [of frustration] to CEC,” and CEC was not entirely prevented from operating its business, but was simply subject to restrictions that restricted, but did not destroy the value of the leases and instead only made operations far less profitable. 

Takeaways

While the Cinemex and Hitz decisions demonstrate that force majeure clauses can provide a basis to avoid the requirements of section 365(d)(3) and obtain rent abatement, they also underscore the importance of the lease’s language.  The text of the force majeure provision may constrain whether, and to what extent, bankruptcy courts will grant rent abatement in force-majeure events.  These cases also confirm that common-law alternatives, such as frustration of purpose, generally will not apply where the parties have contractually allocated risks through a force-majeure clause, or where performance has not been prevented but merely impaired.  Ultimately, even with these potential limitations, the prospect of a successful force majeure or frustration of purpose defense may incentivize lessors to cooperate on lease amendments rather risk complete abatement.  Bolstering such incentive is the fact that section 365(d)(3) does not specify a remedy, leaving the debtor with an argument that the bankruptcy court should exercise its equitable powers to fashion one.  Absent an agreed-upon amendment, a lessor may have only the option of competing with other administrative claimants for unpaid rent.