Daily Development for Friday, February 13, 2004 by: Patrick A. Randolph, Jr. Elmer F. Pierson Professor of Law UMKC School of Law Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu BANKRUPTCY; LEASES; RENT; ADMINISTRATIVE EXPENSES: When a lessee has filed for bankruptcy with the intention of liquidation, landlords may not, during the stub period, absent a lease provision to the contrary, collect prorated rents from their debtor lessees (here ZB Company, Inc. et al, including FAO Schwartz, Inc.) or from the agent that is supplying the debtors with capital (here a venture capital group). The landlords may, however, collect prorated administrative expenses from their debtor lessees during the stub period. In re ZB Company, Inc. et al., 2003 WL 2298230 (Bankr.D.Del.). This case involves the (sad) liquidation of the famous FAO Schwartz chain of toy stores. The debtor's 142 stores virtually all owed rent as of the first of December, 2003, and did not pay it. The debtor filed Chapter 11 bankruptcy, expressing the plan to fully liquidate, on December 3, 2003. This, of course, made the rent obligation for the past due rent an unsecured debt in the bankruptcy proceedings. But the debtor arranged for a liquidator to take possession of the stores and commence "going out of business" sales in all of them. The contract with the liquidator provided that the liquidator would make payments on a daily basis to the debtor for the occupancy of the store premises. These payments were equal to the actual rent obligations that the debtor had with its landlord's on these premises. The debtor, however, refused to pay over these amounts to the landlords, arguing that in bankruptcy courts in the Third Circuit do not recognize an obligation to pay pro rata rent, and the period for which the liquidator was occupying the premises would end before the next rent payment date of January 1, 2004, occurred. The landlords argued that since the debtor was getting revenue from the liquidator for the occupancy of the premises, it should be paying those amounts over to the landlords. The debtor acknowledged that it would owe to the landlords administrative rent for the benefit of occupancy for the balance of the month of December. . But it claimed that it should not be required to pay the administrative rent until the bankruptcy was fully resolved, because some of the leases would be assumed and assigned, and therefore full back rent would be paid, not just administrative rent. Since it didn't know which leases would be assumed, the debtor argued, it was impossible at this point to ascertain those leases as to which a current administrative rent amount should be set. The debtor argued that when the leases were sold, there would be revenue to pay the administrative rent, and that therefore it should be permitted to use the current revenues paid by the liquidator for operating expenses. The court sided with the landlords. It indicated that the presumptive amount of administrative rent in the case of each landlord was the contract rent. Although it acknowledged that in the Third Circuit, unlike in other Circuits, courts would not pro rate an existing rent obligation between the pre and post filing periods, this did not mean that the landlords had not right to collect the value of the occupancy post petition. This was an administrative obligation, and the court has discretion to determine when administrative rents should be paid. But the court concluded that in this case it should exercise discretion to order immediate payment over of the monies received from the liquidator (presumably on the same daily basis that the liquidator was paying the debtor.) The court commented that to defer these payments and to let the debtor spend the money now coming in on administration of the estate was to impose on the landlords the risk that there would be an "administratively insolvent estate" when the time came to pay over the administrative rents. Better to let the landlords have the administrative rents now, since the debtor was receiving payments from the liquidator related directly to the benefit to which those administrative rents related. Comment: The editor is delighted with this practical opinion that cut off what was obviously a carefully concocted scheme by the debtor's counsel - setting their case in the Third Circuit and filing their petition immediately following the rent due date, then negotiating a daily rent from the liquidators - all designed to divert cash from the landlords to the debtor's expenses (read in attorney's fees). It's rare that the editor has much good to say about bankruptcy decisions. 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