The New Normal in Bankruptcy – Consolidated Credits Act Moves Away from Bankruptcy Code to Provide Additional Covid Relief

On December 27, 2020, the Consolidated Appropriations Act of 2021 (the “AAC“) was enacted to provide additional coronavirus stimulus relief to businesses facing the ongoing Covid-19 pandemic. In doing so, the CAA includes several targeted, but temporary, amendments to the Bankruptcy Code (the “Coded”) which will have implications for lenders, owners, sellers and other creditors. In the absence of new legislation, these changes will expire on December 27, 2022, but will continue to affect cases filed before that date thereafter.

  1. PPP loans still not for everyone: CAA attempts to clarify debtor eligibility

The CARES Act, passed at the start of the Covid-19 pandemic, did not specify whether bankrupt debtors were eligible for the Paycheck Protection Program (“PPP“) loans he granted. The Small Business Administration (“SBA”), the agency responsible for implementing the PPP loan program, has previously enacted regulations disqualifying all bankrupt debtors from the program, and it has sought to enforce that regulation in the bankruptcy courts. A dispute ensued over the eligibility of debtors for PPP loans, but no clear consensus emerged.

The CAA attempts to provide certainty about debtors’ eligibility for PPP loans, but instead replaces new uncertainty and additional hurdles. The CAA amends Section 364 and other sections of the Bankruptcy Code to allow debtors (and trustees) in bankruptcy proceedings under Subchapter V of Chapter 11 (for “small business debtors”) , Chapter 12 (for family farms) and Chapter 13 (for individuals), to obtain PPP funds if they are otherwise eligible.But the changes will only go into effect if the SBA determines that these debtors would be otherwise eligible for PPP loans, and its most recent guidelines declare debtors ineligible for PPP loans.For the CAA’s proposal to take effect, the SBA would need to revise these guidelines, and the SBA does not appear to be under pressure to do so. .

If the CAA amendments go into effect, other procedural hurdles impede debtors’ eligibility for PPP. A debtor must seek bankruptcy court approval for any PPP loan, and the bankruptcy court must hold a hearing on the debtor’s request within an expedited seven-day period. If approved, a PPP loan would be treated as a super-priority administrative expense under Sections 364(c)(1) and 503(b) of the Code, unless and until cancelled. In addition, existing lenders to debtors in bankruptcy should be aware that potential amendments to Section 364 also provide that a debtor may obtain a PPP loan notwithstanding any cash collateral or debtor in possession loan agreements in place that would otherwise prohibit subsequent borrowing by the debtor. In addition, the relevant provisions of the Code relating to plan confirmation would also be amended to allow confirmation of a plan that repays a PPP loan in accordance with its terms, notwithstanding the super-priority status of PPP loans in the event of bankruptcy.

Certainly, companies struggling with the pandemic and their lenders and stakeholders would greatly benefit from another round of relief funds. But the availability of such relief for debtors remains uncertain. Will the SBA respond directly to the CAA? Will the courts be asked to step in and interpret the CAA to require the SBA to promptly initiate relief for these troubled debtors? These questions may not be answered without more litigation and confusion.

  1. Creditors get Covid-related relief from preferential liability

During the pandemic, extraordinary measures have been required and (in many cases) taken by creditors and their debtors to address each other’s financial challenges. Catch-up payments, renegotiated credit terms and other forms of forbearance have become the “new normal” between debtors and their sellers, service providers and landlords (among others). The unintended consequence of this new reality has been to overturn the notion of “ordinary course of business” as a defense of preference.

Generally, Section 547 of the Code provides that liens are payments made by a debtor to a creditor within ninety (90) days of the debtor’s filing for bankruptcy and that the debtor (or trustee ) may, in the absence of certain defenses, “recover” in the bankruptcy estate. One of the few preferred defenses available to creditors is the so-called “ordinary course of business” defence.

Recognizing that the circumstances created by the pandemic should not deprive creditors willing to work with debtors of an important preference defense, the CAA is creating a new preference defense to protect a debtor’s deferred payments after March 13 2020. Specifically, the CAA amends Code Section 547 to prohibit suits by a debtor (or trustee) against landlords to recover certain pre-bankruptcy payments under a contract or lease for “covered rent arrears” and “covered supplier arrears”. To benefit from this exemption, (a) the debtor and the owner must have entered into a contract or a lease before the bankruptcy filing, (b) they must have modified this contract or lease after March 13, 2020, and (c) the contract or lease amendment must have postponed or postponed payments normally due under the contract or lease. The preferential exemption will not apply to the payment of fees, penalties or interest imposed in the amendment after March 13, 2020. Although this amendment expires on December 27, 2022, it will continue to apply in any bankruptcy case. started before the expiration date.

While these changes are clearly designed to remove a potential preference penalty for creditors and, in turn, incentivize them to accept financial accommodations with their debtors in the context of pandemic-related business challenges, it remains to be seen whether these changes will actually confer a practical benefit to creditors. Like any new law, this amendment may raise more questions than it answers, such as:

  • What is an “agreement or arrangement”? And should it be written?
  • Will a landlord, seller, or service provider lose protection if the debtor fails to perform the “agreement or arrangement”?
  • Does the “agreement or arrangement” have to be formally modified if the customer defaults?
  • Can a new “agreement or arrangement” protect payments retroactively?
  • Does an agreement reached before March 13, 2020 prevent the parties from entering into a new agreement? Would a new agreement after March 13, 2020 only be possible in the event of a material breach of an agreement prior to March 13, 2020?

For enforceable leases and contracts that involve large monthly payments, the best practice may be to avoid these and other issues where possible by proactively entering into formal forbearance agreements that are designed specifically with requirements of this new defense in mind.

  1. Other CAA Amendments Temporarily Codify Pandemic Relief Previously Provided to Many Commercial Tenants — But at Landlords’ Expense

While landlords may find some comfort in changes to the Preferences Act, which may help them preserve the rent payments they receive, even under renegotiated lease terms, lenders are less likely to accommodate further CAA amendments to the Bankruptcy Code aimed at giving debtors more leasing flexibility. .

Subchapter V debtors will have more time to execute their leases

The CAA amends Section 365 of the Bankruptcy Code to change the time within which small business debtors must perform their lease obligations in Subchapter V bankruptcy cases. so-called “small business debtors” with “non-contingent” liabilities of $7,500,000 or less). Prior to the amendment, Section 365(d)(3) generally provided that the debtor “shall timely perform” all obligations of the lease, subject to continuance by the court for cause. Such an extension could not extend beyond 60 days after the bankruptcy filing, although courts have extended such deadlines beyond 60 days in several large Chapter 11 cases during the pandemic.

The CAA adds a new subsection (B) to Section 365(d)(3), limited to Subchapter V cases, which allows the bankruptcy court to extend the 60-day period by an additional 60 days if the subchapter V debtor “is experiencing or has experienced significant financial difficulty due, directly or indirectly, to the coronavirus disease 2019 (COVID-19) pandemic”.

Deferred rent payments receive priority administrative treatment under Code Section 507(a)(2), but the benefit of such delays unquestionably benefits debtors. In addition, under other provisions of sub-chapter V, the debtor could potentially spread the late payment of rents over a period of several years following the confirmation of a receivership or liquidation plan.

Owners can be reassured that these changes only apply to small business debtors, and after March 27, 2021, there will be fewer when the debt eligibility threshold for new cases of the sub- Chapter V is expected to return from $7,500,000 to just $2,725,625.

All bankrupt debtors will have more time to accept or reject leases

Section 365(d)(4) of the Bankruptcy Code was also amended to extend the time allowed to all debtors (this time not just Subchapter V debtors) to assume or reject non-residential real estate leases to 210 days (from 120 days under the previous law). However, this is not a material departure from the Code or common practice. Under the previous law, the deadline could have been extended “for cause,” and during the pandemic, that deadline was routinely extended. Although the CAA codified the extended deadline, it was not a critical change.

In summary, as the CAA tries to provide additional Covid-related relief to struggling businesses by “socially distancing” itself from the Bankruptcy Code, it remains to be seen whether any of these changes will provide tangible relief or whether such relief is simply illusory. Your trusted legal advisors can help you deal with any issues related to these changes.

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