Section 365(d)(10)¹ was enacted in 1994. It requires the trustee² to:

timely perform all of the obligations of the debtor...first arising from or after 60 days after the order for relief in a case under chapter 11...under an unexpired lease of personal property (other than personal property leased to an individual primarily for personal, family or household purposes), until such lease is assumed or rejected notwithstanding §503(b)(1)...unless the court, after notice and a hearing and based on the equities of the case, orders otherwise...

This article will provide a review of §365(d)(10), including the legislative history, prerequisites for the statute's application and a discussion of performance obligations and administrative claims created thereunder. An analysis of the "equities of the case" language set forth in §365(d)(10) will ensue along with an overview of claims that accrue during the first 59 days following the order for relief. The article will conclude with recommended courses of action for lessors and debtors or trustees when dealing with situations addressed under the statute.

Legislative History

Before §365(d)(10), there was no provision that addressed leases of personalty. Under §365(d)(3), debtors were allowed "an unspecified period of time to determine whether to assume or reject a lease of personal property," a decision that could be made at the debtor's leisure. If lessors were not being paid post-petition, they were forced to move the court to require the debtor to pay. Such post-petition lease payments were only available to the extent that the lessee's use of the leased personalty benefitted the estate.³

If a lessor of personal property failed to receive post-petition, pre-rejection or assumption payments under its lease with a chapter 11 debtor, it was necessary for the lessor to establish that some benefit was conferred upon the estate. Once this hurdle was cleared, the court was faced with the issue of determining the value of the administrative expense due. Different approaches were used by various courts, including a subjective approach (weighing factors such as the amount of use, the property's fair market value and the benefit conferred to the estate) and an objective approach (holding more firmly to the rent as set forth in the lease). Both approaches allowed the court to adjust the amount of the rent due.⁴

Section 365(d)(10) was enacted to accord protections to lessors of personal property and to provide a built-in cushion for debtor-lessees that is unavailable in the case of leases of nonresidential real property. The legislative history indicates the purposes of the statute are to (1) shift the burden of bringing a motion to assume or reject the lease to debtors, and (2) give debtors sufficient breathing room after the petition date to "make an informed decision." See In re Furley's Transport Inc., 263 B.R. 733, 740-41 (Bankr. D. Md. 2001).⁵ Though §365(d)(10) was intended to provide a blueprint for dealing with personal property leases in chapter 11 bankruptcies, it has created some confusion as well.

Requirements for Application of Statute—True Lease or Disguised Loan?

For the most part, a determination of whether or not §365(d)(10) applies can be gleaned from a plain reading of the statute. Clearly, it only applies to cases under chapter 11 and does not apply to leases of personal property to individuals for their personal, family or household use. In a chapter 13 case, when debtors made post-petition payments on a personal property lease without court approval, §365(d)(10) could not act as a shield to them. In re Lively, 266 B.R. 209, 214 (Bankr. N.D. Okla. 1998). If a case under chapter 11 is converted to one under chapter 7, the protections accorded lessors under §365(d)(10) are cut off on the date of conversion. See In re D.M. Kaye & Sons Transport Inc., 259 B.R. 114, 124 (Bankr. D. S.C. 2001).

A more complex issue is whether or not the subject transaction constitutes a true lease. While a transaction may be styled as a "lease," state law could recharacterize it as a secured loan.⁶ The question of whether or not a transaction constitutes a true lease is outside the scope of this article.⁷ Section 365(d)(10) only applies to leasing transactions. This in turn presents an issue as to who bears the burden of proving whether or not the transaction at issue is a true lease. In In re Pillowtex Inc., 349 F. 3d 711, 716 (3rd Cir. 2003), the Third Circuit ruled that the issue is one of state law. The purported lessor of personalty filed a motion under the authority of §365(d)(10) to compel the debtor to make lease payments. The debtor filed an objection to the motion, arguing that the transaction was not a true lease. The court held that since it was the debtor that sought to recharacterize the transaction, it bore the burden of proof on the issue under New York state law. Similarly, in In re Rebel Rents Inc., 291 B.R. 520, 529 (Bankr. C.D. Cal. 2003), the debtor, in opposition to the lessor's motion to compel assumption or rejection of leases, argued that the transactions were disguised security agreements. The court held that the debtor failed to meet its burden of proof on the issue.

Another matter for consideration is whether the debtor's obligation to make payments under §365(d)(10) should be suspended pending a determination of the true nature of the transaction. The debtor in In re The Elder-Beerman Stores Corp., supra, made this argument. In response to a motion filed by the lessor under the authority of §365(d)(10) to compel lease payments, the debtor filed an adversary complaint seeking a declaratory judgment that the subject transactions were actually security agreements. It also sought to avoid making lease payments pending a final determination in the adversary proceeding. Noting that §365(d)(10) provides a 60-day window of breathing space for the debtor coupled with the debtor's inaction until presented with a motion to compel payments brought by the lessor, the court denied the debtor's request and compelled it to perform its obligations under the lease. 201 B.R. at 764. A contrary result was reached in In re Circuit-Wise Inc., 277 B.R. 460, 463-64 (Bankr. D. Conn. 2002). The court held that the lack of qualifying language such as "presumptive" prior to the word "lease" in §365(d)(10) was dispositive. Throwing a bone to lessors, it stated that delaying tactics by debtors who argue that transactions are not true leases can be mitigated via expedited trial schedules and posting of security. The Circuit-Wise court failed to address the burden of proof placed on the party seeking to recharacterize the transaction.

Creditors also have standing to seek recharacterization of leases. In In re Homeplace Stores Inc., 228 B.R. 88 (Bankr. D. Del. 1998), the lessor of personalty under a master lease argued in a motion for summary judgment that the language of the "lease" evidenced an intent by the parties to treat the transaction as a true lease. The lessor maintained that the debtor was equitably estopped from arguing otherwise. The bankruptcy court rejected this argument on the ground that the defense of equitable estoppel, even if applicable to the debtor, could not be maintained against creditors of the estate. Therefore, the creditors' committee was permitted to go forward with an action for recharacterization. Id. at 95-96. Assuming that the subject transaction is in fact a true lease and that the requirements of §365(d)(10) are otherwise met, the parties then need to address the nature of the remedies accorded to the lessor under the statute.

Timely Performance: Current Payments, Administrative Claims and Other Considerations

Leaving aside for now the issue of the debtor's obligations to the lessor during the first 59 days following the order for relief, questions arise relating to the nature of the debtor's performance obligations under §365(d)(10). Sections 365(d)(3) and 365(d)(10) are the only statutes in the Code that require the trustee to perform obligations in a "timely" manner. See, e.g., In re Pyxsys Corp., 288 B.R. 309, 314 (Bankr. D. Mass. 2003).

Leases often impose obligations upon lessees other than payment of rent. In re Muma Services Inc., 279 B.R. 478, 487-88 (Bankr. D. Del. 2002), holds that obligations, such as payment of replacement value upon the loss or conversion of leased property along with the payment of late charges and taxes, are obligations that fall under the purview of §365(d)(10). However, flex rental, repair, handling and drop-off charges were held not to be covered under §365(d)(10), since they only became due because of the rejection of the leases.

Issues frequently arise when debtors fail to tender rental payments to their lessors post-petition. This begs the question of whether an aggrieved creditor who has not received payments due after the first 59 days following the order for relief in a chapter 11 proceeding is entitled to immediate payment, an administrative claim or a mere general unsecured claim for unpaid obligations. The debtor in In re The Elder-Beerman Stores Corp., supra, was directed to resume payments under the disputed lease pending a ruling as to whether the transaction constituted a disguised financing device. 201 B.R. at 764. The In re Rebel Rents Inc., supra, court granted the debtor a 30-day extension to decide whether or not to assume or reject its leases with the lessor creditor—a lessor that moved to compel assumption or rejection. However, the court compelled the debtor to resume making regular monthly payments during this period. 291 B.R. at 532.⁸ Once a lessor receives post-petition lease payments, one court has held that it cannot be ordered to disgorge such payments if the estate later becomes administratively insolvent. In re Leisure Time Sports Inc., 189 B.R. 511, 513 (Bankr. S.D. Cal. 1995).⁹

More often, the controversy centers around whether or not the lessor is entitled to an administrative claim.¹⁰ Most of the cases hold that at the very least, the lessor is entitled to administrative claim for unpaid obligations under the leases that come due after expiration of the 59-day period following entry of the order for relief. The standard applied by the courts varies, however. In re Furley's Transport Inc., supra, holds that §365(d)(10) grants lessors the "extraordinary benefit of an automatic administrative expense, without the usual proofs required under §503(b)(1)(A) to show actual, necessary costs of preserving the estate." 263 B.R. at 740 and cases cited therein.¹¹ In re Raymond Cossette Trucking Inc., 231 B.R. 80, 84 (Bankr. D. N.D. 1999), states that most courts interpret §365(d)(10) "as abrogating the requirements of §503(b)(1), with the lessor automatically becoming entitled to an administrative expense claim for all sums coming due under the lease during the 60-day hold-over period." Similarly, In re Food Etc. LLC, 281 B.R. 82, 85 (Bankr. S.D. Ala. 2001), holds that §365(d)(10) gives a lessor an administrative claim for reasonable attorneys' fees and expenses (which are otherwise due under the subject lease) incurred starting 60 days after the petition date without the necessity of demonstrating a benefit to the estate. However, In re D.M. Kaye & Sons Transport Inc., supra, holds that §365(d)(10) merely provides a "presumptive entitlement" to rent due 60 days after the petition date. 259 B.R. at 119. In re Eastern Agri-Systems Inc., supra, holds that the resultant administrative claim arises under §365(d) and not §503(b)(1). 258 B.R. at 354.

Several lessors applied for allowance of superpriority claims. In most cases, these requests were denied. The court in In re Rebel Rents Inc., supra, discussed the requirements for a claim to be accorded superpriority status. Three criteria must be established: (1) the lessor must be provided adequate protection, (2) the lessor must have an allowable claim under §507(a)(1) and (3) the claim must arise from a stay under §362, the use, sale or lease of property under §363, or the granting of a lien under §364. Having failed to obtain an adequate protection order, the court denied the lessor's request for a superpriority claim. 291 B.R. at 534-35. Similarly, the courts in In re Food Etc. LLC,¹² supra, and In re D.M. Kaye & Sons Transport Inc., supra, denied requests for allowance of superpriority claims under §365(d)(10).

There is a minority view that holds that §365(d)(10) does not give rise to administrative claims for unpaid obligations that arise after the initial 60-day period. The court in In re Palace Quality Service Industries Inc., 283 B.R. 868, 875-78 (Bankr. E.D. Mich. 2002), addressed the issue in detail. It ruled that §§365(d)(3) and 365(d)(10) merely require trustees to remain current on lease payments if they wish to take additional time to decide whether to assume or reject the lease.¹³

Another consideration is the effect of conversion of the case from chapter 11 to chapter 7. Section 365(d)(10) cannot form the basis of an administrative claim for unpaid rent that accrues subsequent to the date of conversion. In re Palace Quality Services Industries Inc., supra, 283 B.R. at 873, FN 3. However, this does not prevent a lessor from applying post-conversion for a claim that accrued while the case was pending under chapter 11. While §348(d) relegates many pre-conversion claims that accrue while the case is pending under chapter 11 to pre-petition non-priority status, the statute does not apply to §503(b)(1) claims. However, under §726(b), §503(b)(1) administrative claims arising under chapter 11 are subordinated to administrative claims that accrue post-conversion. In re Eastern Agri-Systems Inc., supra, holds that claims arising under §365(d)(10) should be accorded the same status as §503(b)(1) claims and therefore should retain their administrative priority even if the case is converted. However, the court held that the §365(d)(10) claim, as one which arose while the case was under chapter 11, should be subordinated to chapter 7 administrative claims. 258 B.R. at 355-56. In re Tel-Central Communications Inc., 212 B.R. 342, 349 (Bankr. W.D. Mo. 1997), holds that claims arising under §365(d)(10) cannot be paid post-conversion until it is determined that there are enough funds in the estate to pay all chapter 7 and 11 administrative expenses.

"Equities of the Case" Considerations

The obligation of timely performance imposed by §365(b)(10) upon the trustee can be modified if "the court, after notice and a hearing and based on the equities of the case, orders otherwise." The statute fails to specify the identity of the party that is required to give notice, leaving open the possibility that such notice, and the resultant hearing, can arise from a response to a motion to compel performance filed by the lessor.

In In re Magnolia Gas Co. LLC, et al., 255 B.R. 900, 917-922 (Bankr. W.D. Okla. 2000), a lessor of equipment filed an application for payment of rent as an administrative expense under the authority of, inter alia, §365(d)(10). A competing creditor filed an adversary complaint, which sought a declaratory judgment that the lessor was not entitled to the administrative claim. Regarding the portion of the claim that accrued after the 59-day period following entry of the orders for relief, the creditor argued that the "equities of the case" warranted a reduction in the amount of the claim. The factors raised in support of this argument were that (1) there were no benefits to the estates since they did not use the leased property during this period, (2) the lessor was an insider of the debtors, (3) the lessor agreed to post-petition modifications of lease amounts and (4) the lessor contributed to alleged environmental violations. Each of these arguments was rejected by the court. The first argument was rejected outright as being legally incorrect. The remaining arguments were rejected, in one way or another, due to a lack of proof on the part of the creditor.

In In re Republic Technologies International LLC, et al., 267 B.R. 548, 552-53 (Bankr. E.D. Ohio 2001), a lessor with a front-loaded lease that contained substantial pre-petition arrears and no post-petition arrears (since no payments were due during the post-petition portion of the lease term) argued that the lease should be "transformed" to spread out the payments. The argument for this proposed transformation was based on the "equities of the case" language of §365(d)(10). It was rejected outright by the court. In re The Elder-Beerman Stores Corp., supra, holds that since the debtor took no action regarding a lease during the 60-day abeyance period, an equitable analysis under §365(d)(10) should not be applied retroactively. However, in In re CCI Wireless LLC, 297 B.R. 133, 140 (Bankr. D. Colo. 2003), the court, using an equities-of-the-case analysis, granted the debtor's motion to reject retroactive to the date of filing since the leased property had been abandoned to the lessor. In re Pan American Airways Corp., supra, holds that a determination on an "equities of the case" argument cannot be made on summary judgment. 245 B.R. at 900. Ultimately, these cases demonstrate that in order for an equities-of-the-case argument to succeed, there must be a sufficient evidentiary showing by the party making the argument.

Claims Arising During the First 60 Days

Section 365(b)(10) addresses obligations of the debtor "first arising from or after 60 days after the order for relief in a case under chapter 11." Invariably, disputes also arise over unpaid obligations that accrue during the initial 59-day period following entry of the order for relief. Most courts hold that the lessor must prove its rights under a §503(b)(1)(A) analysis. As stated by the court in In re Pan Am Airways Corp., supra, "[the lessor] is entitled to an administrative claim for rents due during the first 60 days of the case where [the lessor] can satisfy the requirements of §503(b)(1)(A) that such rents represent the 'actual, necessary costs and expenses of preserving the estate.'" 245 B.R at 900. There is a minority view that no claim accrues during this period.

The diverging views on this issue are best illustrated in In re Rebel Rents Inc., supra. In addition to seeking an administrative claim for amounts coming due under the lease following expiration of the first 60 days of the bankruptcy, the lessor also sought a claim for amounts that accrued under the lease during the initial 60-day period. The opinion notes that courts are divided on the issue. It cites In re Muma Services Inc., In re Furley's Inc. and In re D.M. Kaye & Sons Transportation Inc., supra, as cases supporting the proposition that nothing in §365(d)(10) precludes a lessor from asserting an administrative expense claim under §503(b). However, the In re Rebel Rents Inc. court denied, without prejudice, the lessor's request for an administrative claim for amounts accruing during the first 60 days after the petition date, and indicated it could revisit the issue upon the debtor's assumption or rejection of the subject leases.¹⁴ 291 B.R. at 533-34.

The court in In the Matter of Kyle Trucking Inc., 239 B.R. 198, 201-02 (Bankr. N.D. Ind. 1999), departed from the majority view on this issue. It held that the plain language of §365(d)(10) limits performance to lease obligations that arise from or after 60 days after the order for relief. As stated by the court, "[i]f Congress had intended to give priority to obligations arising during the first 60 days, it would not have limited §365(d)(10) to the obligations arising after that time." It concluded with reasoning similar to the Rebel Rents court—that assumption of the lease requires a cure of the default. However, it went one step further and held that in the event of rejection, rejection damages cannot be accorded administrative priority.

The majority position is more in tune with the legislative history behind §365(d)(10). As noted by Senator Grassley, the statute was not intended to affect payments originally due during the 60-day abeyance period.

Strategic Considerations

Section 365(d)(10) and the above case law contain important implications for handling personal property leases. From the perspective of the trustee or debtor-in-possession, a complete inventory of the estate's personal property leases should be made as soon as possible. Those that burden the estate should be rejected promptly. To the extent property subject to such an agreement is useful to the estate, it should be determined whether or not a viable argument can be made that the agreement is in fact a disguised financing device and not a true lease. If so, this argument can be raised in response to a motion filed by the lessor. If the lessor has not filed a motion, and the recharacterization argument appears to be strong, it is advisable to promptly initiate an adversary proceeding. If the argument is successful, it could result in rendering the lessor's claim as either undersecured or possibly wholly unsecured without priority. Otherwise, a factual analysis should be made to determine whether or not the equities of the case warrant reducing or eliminating the lessor's claim. If so, it will be necessary to prove up facts during a properly noticed evidentiary hearing. If a creditors' committee has been appointed, the debtor or trustee should consider having the committee join in any such proceedings.

From a lessor's perspective, it is prudent to monitor the bankruptcy. If the lease itself or the underlying leased property has value sufficient to warrant litigation expenditures, it is recommended that the lessor promptly file a motion for adequate protection, to compel performance under the lease and to compel assumption or rejection of the lease. If the 60-day period has expired, the moving papers should contain a demand in the alternative for an award of an administrative expense claim. Additionally, if the leased property was used during the 60-day abeyance period, an application for allowance and payment of an administrative expense claim under §503(b)(1)(A) should be made as well. In the event that the lessor is granted adequate protection payments and there is a subsequent default in payments, the lessor should consider filing a motion for allowance of a superpriority administrative claim. In the event that a debtor or trustee seeks to reclassify the transaction, the lessor should request an order directing that the lessee perform under the agreement until there has been a final determination.

By following the above recommendations, attorneys can serve their clients well by reducing the risks and maximizing the recovery permitted under §365(d)(10).

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Footnotes

¹ All statutory references will be to Title 11 of the U.S. Code unless stated otherwise. Return to article

² Or, in the case of a debtor-in-possession, the debtor. See 11 U.S.C. §1107(a). Return to article

³ See In re Eastern Agri-Systems Inc., 258 B.R. 352, 353-54 (Bankr. E.D.N.C. 2000), citing H.R. Rep. No. 103-835, at 50 (1994), U.S. Code Cong. & Admin. News 1994, p. 3340, 3359. Return to article

⁴ See In re The Elder-Beerman Stores Corp., 201 B.R. 759, 762 (Bankr. S.D. Ohio 1996), and cases cited thereunder. Return to article

⁵ Senator Grassley's comments on the legislation indicate that the word "first" as appears in the statute refers to performance that initially becomes due more than 60 days after the order for relief. There is the potential for confusion as to whether the obligations arise 59 or 60 days after entry of the order for relief. The statute speaks of obligations "first arising from or after 60 days after the order for relief" (emphasis added). While Sen. Grassley's comments speak of performance obligations that come due more than 60 days after the order for relief is entered, some of the cases interpret the statute to require performance of lease obligations arising more than 59 days following the order for relief. See, e.g., In re Furley's Transport Inc., 263 B.R. 733, 738 (Bankr. D. Md. 2001). It is the author's opinion that the proper interpretation is 59 days after entry of the order for relief. Tacking these 59 days to the day on which the order for relief is actually entered leaves a total of 60 days. "The purpose of that reference is to make clear the intent that the provision does not affect payments originally due prior to 60 days before [sic] the order of relief." See In re Pan American Airways Corp., 245 B.R. 897, 899-900 (Bankr. S.D. Fla. 2000), citing 140 Cong. Rec. S14462 (Oct. 6, 1994). Return to article

⁶ In In re Resource Technology Corp., 254 B.R. 215, 226 (Bankr. N.D. Ill. 2000), the court was faced with the issue of whether or not an agreement by a debtor to remove methane gas from a landfill was in fact a lease. The court held it was not, noting that the term "lease" as defined in Black's Law Dictionary means an agreement by the owner of property to allow exclusive possession of that property by another person for a defined period of time, in exchange for rent, with the property reverting to the lessor at the end of the period of possession. The case is mentioned to illustrate that disputes as to whether or not agreements constitute leases do not, ispso facto, require a determination that they are disguised financing transactions if they are shown not to be leases. Return to article

⁷ However, Fla. Stat. §671.201(37) (U.C.C. §1-201(37)) is the proper starting place to commence research on this issue. Return to article

⁸ The court further ruled that the debtor was prohibited from using the leased property until monthly payments were resumed. Return to article

⁹ The case arose under §365(d)(3). Return to article

¹⁰ Although in the context of determining whether or not an administrative claim arises, the court may rule on an application for payment of the claim. See In re Brennick, 178 B.R. 305 (Bankr. D. Mass. 1995), holding that an administrative expense claim arising under §365(d)(3) while the case is pending under chapter 11 should be paid immediately by the chapter 7 trustee following conversion. Return to article

¹¹ The court also held that §365(d)(10) claims first arise not upon invoice dates, but only when, according to the lessor's invoices, they become due. 263 B.R. at 738. Return to article

¹² The In re Food Etc. LLC court noted that other sections of the Code that create superpriority claims do so explicitly. 281 B.R. at 88. Return to article

¹³ Page 875 of the opinion lists citations of cases on both sides of the issue. Return to article

¹⁴ The issue was deferred by the court for the reason that if the leases would be assumed, the debtor would be obligated to cure any default (and thus pay off any arrearages). If they were rejected, the rejection would give rise to a claim for rejection damages. Presumably, in the event of rejection, the lessor would move the court for allowance of an administrative expense claim for the use of the leased property during the first 60 days of the bankruptcy as an element of the rejection damages. Return to article