By Heike M. Vogel, Eric H. Horn & Evan M. Goldman

Continuing on our previous client update regarding changes in bankruptcy rulings due to the COVID-19 pandemic, we analyze the recent Illinois Bankruptcy decision Hitz Restaurant Group, and its ruling regarding enforcement of commercial lease terms and force majeure clauses. It will be interesting to see if other courts will follow suit, and it is certainly informative to commercial landlords and business tenants seeking relief at this time.

Using Section 365(d)(3) to Enforce the Lease Obligations

Section 365(d)(3) requires that a debtor timely perform all the obligations arising after the filing of the bankruptcy under any unexpired lease of nonresidential real property until such lease is assumed or rejected.

In other words, Section 365(d)(3) ensures landlords that a debtor pays its rents as they become due even after its bankruptcy filing until the debtor either rejects the lease and vacates the premises or assumes the lease and assigns it to a new tenant.

In the Hitz[1] matter, the Debtor Hitz Restaurant Group filed for bankruptcy on February 24, 2020. The Landlord, Kass Management Services, Inc., filed a motion with the Bankruptcy Court seeking to enforce the lease obligations by the Debtor, to pay post-petition rent under Section 365(d)(3) of the Bankruptcy Code.

How COVID Impacted the Debtor’s Bankruptcy

Just a few weeks after the Debtor filed for bankruptcy, Illinois Governor J. B. Prizker, faced with the COVID-19 pandemic, issued an order that effectively closed down restaurants in the state.

Specifically, Governor Prizker ordered that “all businesses in the State of Illinois that offer food or beverages for on-premises consumptions must suspend service for and may not permit on-premises consumption.”

However, the order permitted restaurants, and indeed encouraged them, to serve food and beverages for off-premises consumption, by in-house delivery, third-party delivery, drive-through, and curbside pick-up. Restaurants were also permitted to offer food and beverages for carry-out as long as they could ensure that their patrons maintained adequate social distancing.

The Force Majeure Clause

In the Hitz  matter, the Landlord had asked the Bankruptcy Court to order the Debtor to timely pay its post-petition rent in accordance with Section 365 of the Bankruptcy Code, but the Debtor argued, and the Court agreed, that it is excused from paying rent because of the force majeure clause under the lease. The lease’s force majeure clause stated as follows:

Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by … laws, governmental action or inaction, orders of the government … Lack of money shall not be grounds for Force Majeure.

The Bankruptcy Court’s Reasoning about the Governor’s Order and the Force Majeure Clause

Judge Donald R. Cassling sided with the Debtor in its argument that Governor Prizker’s order effectively triggered the force majeure clause under the lease with the Landlord.

Indeed, Judge Cassling ruled that “his order unquestionably constitutes both ‘governmental action’ and issuance of an ‘order’ as contemplated by the language of the force majeure clause.”

Judge Cassling further determined that the “order and its extensions unquestionably ‘hindered’ Debtor’s ability to perform by prohibiting Debtor from offering ‘on-premises’ consumption of food and beverages,” and “[f]inally, the order was unquestionably the proximate cause of Debtor’s ability to pay rent, at least in part, because it prevented Debtor from operating normally and restricted its business to take-out, curbside pick-up and delivery.”

Reducing the Debtor’s Obligation in Proportion to Reduced Ability to Generate Revenue

 While the Bankruptcy Court agreed with the Debtor that the force majeure clause under the lease was triggered by Governor Prizker’s shutdown order, it recognized that the Debtor was not prevented from offering some services in the way of take-away orders and home deliveries.

Given that fact, Judge Cassling did not let the Debtor off the hook entirely, and instead held that Debtor’s obligation to pay rent is reduced in proportion to its reduced ability to generate revenue due to the shutdown order.

Judge Cassling found that the debtor was excused from paying 100% of its post-petition monthly rent payments because the force majeure clause under the lease was triggered by the “Shutdown” order of the Illinois Governor, which impacted its ability to generate revenue.  The Court concluded that a reduced obligation had to be paid to the landlord.

Calculating the Debtor’s Reduced Obligation

Since the Debtor conceded that approximately 25 percent of the restaurant square footage could have been used for carry-out, curbside pick-up, and delivery purposes, the Court concluded that the Debtor does owe at least 25 percent of the rental payments for April, May and June 2020, and that such payments must be paid by the Debtor to the Landlord pursuant to Section 365(d)(3) of the Bankruptcy Code.

This latest bankruptcy ruling arising out of the coronavirus-related measures should be considered by landlords as they are trying to enforce their commercial lease terms, especially against a business tenant that is filing for a Chapter 11 proceeding under the Bankruptcy Code. Prior to seeking relief from the Bankruptcy Court, landlords are advised to review the force majeure clauses under their commercial leases. While the Hitz opinion is not binding on other courts, it certainly is persuasive. We suspect that other courts will follow suit and grant rent abatement requests to debtor commercial tenants on similar grounds.

[1] In re Hitz Restaurant Group, Bankruptcy Court Northern District Illinois, Eastern Division, Case No. 20-05012, Doc. No 48. (June 2, 2020).