Bankruptcy Code Section 365(d)(5) provides personal property lessors with important rights concerning lease payments that come due after a lessee commences a U.S. bankruptcy proceeding. Generally, that section requires that the lessee "perform all of the obligations of the debtor" under an unexpired personal property lease (including the obligation to pay rent) that arise on and after the 60th day following a bankruptcy filing, until the debtor makes a decision to assume or reject the lease.

Background

Recently, in the Avianca Holdings bankruptcy case,¹ the U.S. Bankruptcy Court for the Southern District of New York affirmed that Bankruptcy Code Section 365(d)(5)'s requirement that a debtor "perform all obligations" under a lease means exactly what the text of that provision says. To that end, the bankruptcy court ordered the debtor (Avianca) to comply with lease terms that required payment of certain prepetition leasing fees characterized as "additional rent" under the terms of the lease that were due after the bankruptcy filing and before the leases were later rejected. Notably, the Court required the payments to be made even though a) the fees were payable to a third party, not the lessor; b) the fees related to services performed and completed well before the bankruptcy filing date; and c) the payments potentially were at odds with the policy reasons surrounding the enactment of Section 365(d)(5).

This ruling resolved a dispute between the debtors (Avianca) and two entities (Initiators) that assisted Avianca with initiating and locating commercial aircraft leases prepetition. The Initiators had assisted Avianca with entering into approximately 20 separate commercial aircraft leases that remained in effect as of the petition date. Instead of paying fees owed to the Initiators for their services at the time the leases became effective, the relevant aircraft leases each required Avianca to pay the Initiators' fees over time in monthly installments. Each monthly fee was listed in the applicable aircraft lease as "additional rent" and was payable to the Initiator in accordance with a well-defined payment schedule (such that the amount of fees due for each month following the bankruptcy filing was readily and easily ascertainable).

Avianca sought bankruptcy protection in May 2020 in the wake of COVID-19 outbreaks earlier that year. Shortly after the commencement of Avianca's bankruptcy proceeding, Avianca entered into substantially identical "usage stipulations" with nearly all of its aircraft lessors. The "usage stipulations" modified certain of Avianca's obligations under the lease, including providing that Avianca would have to pay only "power by the hour" rent during the bankruptcy case, rather than the rent specified in the lease, pending a final decision by Avianca as to whether the underlying lease would be assumed or rejected. The usage stipulations each stated that all rights regarding future assumption or rejection of the relevant lease were reserved. Other than suspending the obligation to pay rent in favor of power by the hour rentals, the usage stipulation did not explicitly address payment of the "additional rental" amounts due to the Initiators, nor were the Initiators parties to any of the aircraft usage stipulations (which were executed between the applicable lessor and Avianca).

The 60th day following the commencement of Avianca's bankruptcy cases occurred on July 9, 2020. During the period after that date, Avianca and the underlying lessors continued to negotiate regarding assumption or rejection. Ultimately, Avianca reached agreements to continue the use of substantially all of the aircraft for which the original leases included payment of "Initiator" fees. In most cases, Avianca and the lessor agreed that the existing lease would be rejected, with the parties to execute a new, replacement lease for the aircraft. Such agreements provided that the effective rejection date for each aircraft would be the effective date of the new lease. However, the effective date for most new leases did not occur until early 2022.

Dispute and Ruling Regarding Initiator Claims

The Initiators filed administrative claims seeking allowance and payment of the Initiator fees that were payable as "additional rent" under the original leases through the rejection date. Avianca disputed its obligation to pay such claims, so the Initiators filed a motion seeking alternatively a) allowance of administrative claims for the post-bankruptcy (but pre-rejection) fees that accrued after July 9, 2020, through the relevant rejection effective date; or b) an order compelling payment of such amounts under Bankruptcy Code Section 365(d)(5).

In response, Avianca claimed that it was not obligated to pay the Initiator fees post-petition because a) such amounts did not constitute obligations under the leases arising after July 9, 2020, and instead represented deferred obligations that accrued prior to Avianca's bankruptcy filing; or b) the obligation to pay such amounts was superseded by the terms of the "usage stipulations" executed between Avianca and the aircraft lessors.

Ultimately, the Court rejected both arguments and held that the Initiators were entitled to the amounts due to them under the underlying lease agreements for the period from July 9, 2020, through the applicable rejection date. In so holding, the Court focused principally on the text of 365(d)(5). The payments due to the Initiators were set forth in the aircraft lease (and constituted one of multiple payment obligations under that lease) and, importantly, were payable according to a fixed schedule (raising no questions as to which obligations were payable from and after July 9, 2020). The Court noted that payment of such amounts could be at odds with the policies set forth in the legislative history underlying Section 365(d)(5), which provision was intended to protect lessors themselves (not necessarily other third parties for whom amounts are owed under lease documents) from suffering financial harm while the lessor awaits a final decision from the debtor concerning whether the lessor's lease will be assumed or rejected. Nevertheless, the Court held that such policy complications could not override the explicit text of Section 365(d)(5).

Further, the Court did not identify any provision of the usage stipulation that explicitly addressed payment of the Initiator fees. Although the usage stipulations stated that the reduced PBH rentals and other amounts payable per the usage stipulation would "satisfy any and all rights of the [stipulation signatories] to administrative expense status or priority in payment … for any claims arising out of or related to the [usage stipulation term]", the Court held that the language did not expressly address amounts due to the Initiators (who were not parties to the usage stipulation). Because the usage stipulations did not address amounts due to the Initiators, and otherwise preserved all other lease rights pending the decision to assume or reject the leases, the Court held that the usage stipulations did not override the leases' requirement to pay Initiator fees.

Notably, the Court did not hold that the Initiators were entitled to an administrative claim, because payment of the Initiator fees did not provide a post-petition benefit to the estate (such a benefit is a prerequisite to allowance of an administrative claim). However, because Section 365(d)(5) does not require a showing of any benefit to the estate in order to compel payment, the Court nevertheless ordered payment of the Initiator fees over Avianca's objection.

Drafting and Structuring Considerations

Certain facets of the Avianca Holdings opinion may impact drafting and structuring decisions made in connection with future airline bankruptcies. Because the Court was very focused on the explicit schedule for amounts payable to the Initiators (which left no disagreement as to amounts that were due after day 60), any parties that want payments to third parties included in a lease to remain payable during a bankruptcy (absent overriding language in a usage stipulation) will need to ensure there is no ambiguity regarding when such payments are due. Any potential flexibility regarding the ability to make any such payments before day 60 could be fatal to a post-bankruptcy claim for such payments.

Furthermore, the timing and mechanics of assumption or rejection of a lease may impact how long any third-party fees (similar to the ones payable to the Initiators) will continue to accrue. In Avianca Holdings, the airline reached an agreement in principle regarding retention of most of the aircraft in question months before the effective rejection date of the old leases (that included payment of Initiator fees). Accelerating the effective date of rejection of the leases in question could have reduced the amount of fees payable to the Initiators, as the effective date of assumption or rejection (not the date of a deal regarding potential terms of assumption or rejection) dictates when the 365(d)(5) payment clock stops.

Notes

¹ In re Avianca Holdings S.A., et al., No. 20-11133 (MG) (Bankr S.D.N.Y. Jan. 26, 2023) (2023 WL 494255).