January 28, 2021 - United States of America

The New Normal – The Consolidated Appropriations Act Temporarily Codifies Pandemic-Related Bankruptcy Relief for Commercial Tenants (But It’s Not All Bad For Landlords)

On December 27, 2020, the Consolidated Appropriation Act of 2021 (the “CAA”) was enacted to provide additional coronavirus stimulus and relief for businesses challenged by the ongoing COVID-19 Pandemic. In doing so, the CAA includes several targeted, but temporary, changes to the Bankruptcy Code (the “Code”) designed to provide certain debtors with greater flexibility with respect to their leases (which may negatively affect landlords) while ensuring that creditors are not penalized under the preference law for renegotiating their lease terms (which should benefit landlords). Absent further legislation, these changes will sunset on December 27, 2022, but will continue thereafter to affect cases filed prior to that date.

1. Small Business Debtors Receive an Extended Time to Perform Under Leases

Many businesses have struggled to pay rent due to the COVID-19 pandemic. Recognizing that debtors may need more breathing room when they file bankruptcy, the CAA adds a new section to section 365(d)(3) of the Code applicable to so-called “small business” debtors which qualify for treatment under Subchapter V of the Code. This new section extends the previous 60-day period for such debtors to timely perform all lease obligations by an additional 60 days, so long as the debtor “is experiencing or has experienced a material financial hardship due, directly or indirectly, to the coronavirus disease 2019 (COVID-19) pandemic.” Many bankruptcy courts were already granting such relief during the worst of the pandemic-related shutdowns. The CAA does confirm that obligations deferred by debtors during this extended period will receive administrative priority treatment under Section 507(a)(2) of the Code, but the benefit of these delays unmistakably inures to debtors. Further, under other provisions of Subchapter V, the debtor potentially could spread out the delayed rental payments over a period of several years following the confirmation of a bankruptcy plan of reorganization or liquidation.

Landlords can take some comfort that this change will have a limited application and implications. First, this change does not apply to all bankrupt debtors. Rather, it only applies to debtors qualifying under Subchapter V of the Code. Subchapter V applies only to small business debtors with non-contingent liabilities of $7,500,000 or less (under current limits). Second, after March 27, 2021, there should be fewer Subchapter V debtors, because the debt eligibility threshold for new subchapter V cases will be reduced from $7,500,000 to $2,725,625.

2. All Debtors Receive an Extended Timeframe to Assume or Reject Their Leases

Section 365(d)(4) of the Code was also amended to extend the deadline for all debtors (not just subchapter V debtors) to assume or reject non-residential real property leases. Under the prior law, debtors had only 120 days to make such a determination. The CAA extends this time period to 210 days.

It is doubtful that this change will have much of a practical effect. It was already fairly common for bankruptcy courts to extend the prior deadline during the pandemic. However, it is certainly possible that debtors will seek to take advantage of this newly guaranteed ability to hold landlords hostage longer in order to force greater lease concessions.

3. Certain Rent Payments Made After March 13, 2020, Are Exempt from “Preference” Exposure

The CAA isn’t all bad for landlords, as it does correct one potential looming problem for landlords down the road. The CAA recognizes that the economic distress suffered by commercial tenants as a result of pandemic-related measures resulted in many landlords agreeing to provide tenants with lease modifications and rent deferrals to ease their pain. However, the alteration of such payment arrangements likely resulted in many payments being received by landlords “outside the ordinary course of business.” This might have the unintended consequence of exposing such outside the ordinary course payments to heightened risk of being recovered by debtors as “preferential transfers.” To avoid this unfair result, the CAA adds a new defense to section 547 of the Code which provides in concept that if adjusted/modified/deferred payments are received by a landlord in the 90 days prior to a bankruptcy under an explicit agreement with the debtor, they are protected.

To qualify, there are a few specific prerequisites: (a) the debtor and the landlord must have entered into a lease before the bankruptcy filing, (b) they must have amended the lease after March 13, 2020, and (c) the lease amendment must have deferred or postponed payments otherwise due under the lease. Importantly, only rent payments are protected. This exemption from preference liability will not apply to the payment of fees, penalties, or interest imposed in the post-March 13, 2020, amendment.

If you have any questions regarding the application of these changes to the Bankruptcy law, please do not hesitate to contact Jonathan Aberman (312-627-2515 or [email protected]), Mark Silverman (312-627-8292 or [email protected]), Dawn Peacock (312-627-2483 or [email protected]), or your Dykema relationship attorney.

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