Breaking New Ground: Delaware Bankruptcy Court Grants Administrative Priority For Postpetition, Prerejection Lease Indemnification Obligations

Under the Bankruptcy Code, a bankruptcy trustee or chapter 11 debtor in possession ("DIP") is required to satisfy postpetition obligations under any unexpired lease of commercial property pending a decision to assume or reject the lease. Specifically, section 365(d)(3) requires the trustee, with limited exceptions, to "timely perform all the obligations of the debtor . . . arising from and after the order for relief" under any unexpired lease of nonresidential real property with respect to which the debtor is the lessee. The application of section 365(d)(3) and, in particular, the timing of certain "obligations" arising under an unexpired lease has created some controversy. A Delaware bankruptcy court added fuel to the fire in a ruling handed down earlier this year. In a matter of first impression, the court held in WM Inland Adjacent LLC v. Mervyn's LLC (In re Mervyn's Holdings, LLC), 2013 BL 5408 (Bankr. D. Del. Jan. 8, 2013), that a claim arising from an indemnification obligation under a commercial lease was entitled to administrative expense status under section 365(d)(3).

Payment of Postpetition Commercial Lease Obligations

As noted, section 365(d)(3) provides that a trustee or DIP, with certain exceptions, "shall timely perform all the obligations of the debtor . . . arising from and after the order for relief under any expired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title." Added to the Bankruptcy Code in 1984, the provision was intended to ameliorate the immediate financial burden borne by commercial landlords pending the trustee's decision to assume or reject a lease. Prior to that time, landlords were routinely compelled to seek payment of rent and other amounts due under a lease by petitioning the bankruptcy court for an order designating those amounts as administrative expenses. The process was cumbersome and time-consuming. Moreover, the landlord's efforts to get paid were hampered by the standards applied in determining what qualifies as a priority expense of administering a bankruptcy estate. Section 503(b)(1) of the Bankruptcy Code provides that allowed administrative expenses include "the actual, necessary costs and expenses of preserving the estate." Rent payable under an unexpired commercial lease during a bankruptcy case arguably falls into this category. Even so, section 503(b)(1) has uniformly been interpreted to require that in addition to being actual and necessary, an expense must benefit the bankruptcy estate to qualify for administrative priority. Prior to the enactment of section 365(d)(3), "benefit to the estate" in this context was determined on a case-by-case basis by calculating the value to the debtor of its "use and occupancy" of the premises, rather than looking to the rent stated in the lease. Moreover, even if a landlord's claim for postpetition rent was conferred with administrative priority, the Bankruptcy Code did not specify when the claim had to be paid. Section 365(d)(3) was designed to remedy this problem. It requires a trustee or DIP to remain current on lease obligations pending assumption or rejection...