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November 23, 2020 Articles

COVID-19 Restrictions and Implications for Debtors in the Northern District of Illinois

Bankruptcy court relieves debtor from post-petition rent, citing coronavirus restrictions.

By Micah C. Zeno

In a matter pending before the Bankruptcy Court for the Northern District of Illinois, creditor Kass Management Services filed a motion to force Hitz Restaurant Group to pay post-petition rent under section 365(d)(3) of the Bankruptcy Code. In re Hitz Rest. Grp., 616 B.R. 374 (N.D. Ill. 2020). Section 365(d)(3) requires a debtor to perform its obligations under an unexpired lease of commercial property arising after an order for relief. Congress added section 365(d)(3) to the Bankruptcy Code in 1984 to provide relief to landlords who were often forced into the uncomfortable position of leasing to a bankrupt tenant who had not assumed the unexpired term of a lease but whom the landlord could not evict. In this case, Hitz Restaurant filed for Chapter 11 bankruptcy in February 2020 and subsequently failed to pay its rent for March through June. The restaurant argued that its liability to pay post-petition rent had been excused by the force majeure clause in its lease. The force majeure clause provided that

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 . . . governmental action or . . . orders of government. . . . Lack of money shall not be grounds for Force Majeure.

On March 16, 2020, Illinois Governor J. B. Pritzker issued an executive order suspending services of all businesses that offered “on-premises consumption” of food and beverages. Hitz argued that the governor’s order had triggered the force majeure clause in Hitz’s lease with Kass Management. While restricting certain on-premises activities, the order notably permitted and encouraged businesses to provide off-premises consumption by drive-through, curbside, and at-home delivery services, and specifically provided that “customers may [still] enter the premises to purchase food or beverages for carry-out.”

The court concluded that the governor’s executive order had “unambiguously triggered” the force majeure clause in the lease. First, the order “unquestionably constitute[ed]” both “governmental action” and an “order of government” under the lease. Second, the order had hindered Hitz’s ability to perform by prohibiting the restaurant from providing on-premises dining and otherwise restricting the restaurant’s services. Consequently, the order was the proximate cause of the restaurant’s ability to pay its rent.

Kass insisted that the restaurant’s failure to pay rent had resulted from a lack of money and did not constitute a force majeure event under the lease. In rejecting this assertion, the court stated that to the extent there was a conflict between the two provisions in the lease, the specific “orders of government” provision preempted the general “lack of money” exception. “[A] lessee’s lack of money,” the court noted, “could arise from any number of events. . . . By contrast, the Debtor’s failure to pay post-petition rent is the direct and proximate result, at least in part, of Governor Pritzker’s executive order.”

In the legal equivalent of a Hail Mary pass, Kass suggested that Hitz could have paid its rent by applying for a loan from the Small Business Administration and that Hitz’s failure to do so had worked to preclude the restaurant from exercising the force majeure clause. The court summarily rejected this argument. “Nothing in that [force majeure] clause requires the party adversely affected by government action or orders to borrow money to counteract their effects.”

Yet, in an astute application of business savvy, the court observed that while the governor’s order prohibited the restaurant from offering on-premises dining, Hitz was not without alternatives.

[D]ebtor is not off the hook entirely. Governor Pritzker’s executive order did not prohibit Debtor from performing carry-out, curbside, pick-up, and delivery services. . . . It follows that, to the extent that Debtor could have continued to perform those services, its obligation to pay rent is not excused by the force majeure clause.

In re Hitz Rest. Grp., 616 B.R. 374 (italics added).

The court then reduced the restaurant’s obligation to pay rent in proportion to its ability to generate revenue under the executive order.

On this issue, although lamenting that “[n]either party offered much assistance to the Court,” the court noted that Hitz estimated that the governor’s order had rendered 75 percent of Hitz’s leased space unusable, namely the dining room and bar. The remaining area—the kitchen—Hitz conceded could still have been used under the governor’s order. Interpreting this estimate as a judicial admission, the court held that the restaurant owed “at least 25 percent of the rental payments” (italics added) for those months after the governor issued his executive order—April, May, and June. Hitz was responsible for the full amount of its March rent. The court further noted that later required rent payments were likely to increase as the governor gradually lifted coronavirus restrictions.

Interestingly, the court’s judgment provides a silver lining for the creditor. The court stated that it had not yet conducted an evidentiary hearing to determine the final amount of rent due during the pendency of the governor’s order. Thus, under the court’s “at least” judgment, the court could later determine that Hitz’s rent obligation should be greater than the 25 percent minimum admitted by the debtor. Arguably, such estimates based on square footage are more applicable to retail outlets other than restaurants. A more appropriate measurement might be the average gross revenue during that time for comparable establishments within the same or similar geographical area, adjusted where necessary for the disproportionate impact of COVID-19 restrictions.

The court’s opinion is also a cautionary tale for contract attorneys and drafters of force majeure clauses. In rejecting the creditor’s argument that the debtor should have applied for a loan in order to satisfy its rent payments, the court noted that the creditor could not cite any language from the lease to support its argument. Thus, the court was left to resort to the “plain language of the force majeure clause in the lease.” Had the creditor included a mitigation provision in its force majeure clause, then it is quite possible that the creditor would have been able to recover more than 25 percent of the amount it was owed. What is less clear, however, is the likelihood of success of a bankrupt debtor-in-possession in seeking a loan or other relief in the midst of a pandemic-driven economic crisis.

Micah C. Zeno is an associate at Gordon Arata Montgomery Barnett in New Orleans, Louisiana.

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