Bankruptcy Court Denies Retail Debtor’s State-Law Based Arguments to Avoid Paying Rent During Chapter 11

Pillsbury Winthrop Shaw Pittman LLP

A recent Chuck E. Cheese decision rejects the debtor’s/tenant’s request to avoid paying rent based upon state law equity arguments.

TAKEAWAYS

  • CEC’s leases expressly do not permit rent relief even if force majeure is triggered.
  • CEC’s leases not entirely frustrated due to its ability to use the premises as further evidenced by lease assumption.
  • CEC is the first major bankruptcy decision to hold rent abatement not available due to pandemic distress.

This is the ninth in a series of alerts on insolvency topics affecting real estate, and Part Two of our discussion of the recent Chuck E. Cheese decision where the bankruptcy court rejected the debtor’s efforts to defer and avoid paying rent during and after the initial 60-day period of the case. In Part One, we discussed CEC’s efforts to obtain a super rent holiday (i.e., beyond the first 60 days of the case) under certain provisions of the Bankruptcy Code.

This alert focuses on debtor CEC’s non-bankruptcy theories that the COVID-19 pandemic and government responses: (i) triggered the force majeure clauses in the debtor’s leases; and (ii) resulted in a frustration of purpose of those leases, thereby excusing CEC’s obligations to perform under them. As such, state law equitable remedies like frustration of purpose were unavailable. Even if the remedy was available, the debtor failed to establish frustration of purpose because the leasehold interests were not rendered worthless by the pandemic and government regulations that limited CEC’s operations.

Like many other retail operators, CEC Entertainment, Inc. (“CEC”), operator of Chuck E. Cheese restaurants, has seen its business severely curtailed by the COVID-19 pandemic and related governmental orders. CEC’s distress ultimately led to its “free-fall” bankruptcy filing in June 2020.

After obtaining an order to defer rent obligations for 60 days (per the Bankruptcy Code), and in an effort to preserve cash, CEC filed an additional motion, based in part upon state law theories, in which it sought to further delay or abate rent due to the COVID-19 pandemic and related governmental restrictions until the restrictions were lifted. CEC’s “abatement” motion initially sought to excuse CEC’s obligation to pay rent at 141 locations across 12 states and was opposed by several of the debtor’s landlords. Likely concerned that CEC might win, and “bad law” would be created, many objections filed by landlords were resolved; but six landlords, located in North Carolina, Washington, and California prosecuted their objections and were ultimately vindicated.

CEC argued that it should be excused from rent payments as a matter of state law because: (i) the COVID-19 pandemic and related governmental regulations triggered the force majeure clauses in CEC’s leases; and (ii) governmental regulations which limited the debtor’s operations entirely “frustrated the purposes” of the debtor’s leases.

Force Majeure

As discussed in our companion alert, Bankruptcy Code section 365(d)(3) requires strict compliance with all lease obligations until the debtor decides to assume or reject the lease. However, if state law excuses a debtor from complying with one or more of its lease obligations, then section 365(d)(3) will generally honor state law.

Pointing to state law, commercial tenants, in and out of chapter 11, have argued that the COVID-19 pandemic and related governmental orders have triggered force majeure clauses in their leases and thus excused them from having to make rent payments. Generally, force majeure clauses excuse performance of contractual obligations upon the occurrence of a covered event which is beyond the control of either party to the contract. See e.g., In re CEC Entertainment, 2020 WL 7356380, at *5 (Bankr. S.D. Tex. 2020). These contractual provisions allocate risk when performance is impacted due to the occurrence of events that could not have been anticipated or controlled by the parties at the time of contracting.

For Pillsbury alerts on force majeure primarily outside of chapter 11, please see our Tour de Force client alert series (last issue dated December 3, 2020, available at Tour de Force: Is Force Majeure in Civil Law Jurisdictions a Superior Doctrine?). While many non-bankruptcy COVID-19 force majeure cases remain in their pre-trial phases, some have been decided, with many rejecting the tenant’s efforts to avoid paying rent. See, e.g., East 16th Street Owner LLC v. Union 16 Parking LLC, 2020 WL 7569294, at *1 (N.Y. Sup. Ct. 2020) (ordering tenant to pay rent because force majeure clause in lease did not permit tenant to withhold rent); 35 East 75th Street Corp. v. Christian Louboutin L.L.C., 2020 WL 7315470, at *1 (N.Y. Sup. Ct. 2020) (ruling in favor of plaintiff landlord and ordering defendant tenant to pay rent despite the impact of COVID-19). Chuck E. Cheese represents the first major decision, after trial, in a chapter 11 proceeding to reject a commercial debtor’s/tenant’s effort to rely upon theories of force majeure and frustration of purpose to avoid paying rent.

CEC’s Leases Expressly Do Not Permit Rent Relief Even if Force Majeure is Triggered

The force majeure clauses in CEC’s leases for its North Carolina and Washington locations excused performance for “acts of God,” “unusual government restriction, regulation or control,” or “any other condition beyond the reasonable control of such party.” Critically important, however, the clauses specified that they “shall not apply to the inability to pay any sum of money due hereunder or the failure to perform any other obligation due to the lack of money or inability to raise capital or borrow for any purpose.” Based upon plain language of the leases, the bankruptcy court ruled that “[r]ent is a ‘sum of money due.’” Consequently, the force majeure clauses did not permit the debtor to delay or reduce its rent obligations.

While the California leases contained “force majeure carve-out,” and “anti-force majeure” clauses, the conclusion was the same – the leases did not permit the debtor rent relief even if the force majeure event was triggered. Consequently, the bankruptcy court found that neither of the California leases permitted CEC to abate or reduce rent due to force majeure.

As an aside, Chuck E. Cheese is distinguishable from In re Hitz Restaurant Group, 616 B.R. 374 (Bankr. N.D. Ill. 2020) (discussed in a prior installment of this series). Rightly or wrongly, the court there concluded that rent obligations were relieved when force majeure was triggered, and that COVID-19 and government regulations triggered the force majeure provisions of the lease.

Frustration of Purpose

Despite the fact that it sought to assume the leases under its plan, CEC also argued that its rent payments should be excused under the doctrine of frustration of purpose. CEC believed that the doctrine applied because the pandemic and related government regulations entirely frustrated the purpose of its leases, which it asserted is to operate family entertainment centers. The six lessors countered, arguing that the force majeure and anti-force majeure clauses superseded the doctrine.

The bankruptcy court rejected CEC’s arguments. First, it ruled that under state law a tenant cannot avail itself of the frustration doctrine where the parties had already allocated the very risk CEC was now complaining of. Second, the bankruptcy court ruled that even if the doctrine did apply, the purpose of the leases could not have been frustrated because the leased premises could be put to other uses. The court reasoning included that CEC sought to assume the leases as part of its plan of reorganization, which by definition proved that the leases were not rendered valueless. It could not find that the value of performance under the leases was totally destroyed while at the same time CEC sought to retain them.

Conclusion

The Chuck E. Cheese decision represents the first major chapter 11 decision aligning with those COVID-19 era cases addressing whether pandemic-caused economic distress can overcome an absolute rent payment obligation in a tenant’s lease. These cases generally stand for the proposition that where, as in Chuck E. Cheese, the lease has effectively a force-majeure carve-out – a provision that says the occurrence of a force majeure event does not excuse the rent payment obligation – the nature of the force majeure is irrelevant, and the parties’ contract will be enforced. Chuck E. Cheese may test the perception by some that bankruptcy courts are more flexible than non-bankruptcy courts to deploy equitable remedies rather than the terms of the parties’ contract. In any event, if followed by other bankruptcy and non-bankruptcy courts, we expect this is welcome news to landlords (as well as counterparties to other forms of contracts) threatened with arguments that the plain meaning of the applicable contract can be avoided based upon the pandemic and corresponding equitable theories like frustration of purpose.

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