On December 27, 2020, the Consolidated Appropriation Act of 2021 (the “CAA“) was enacted to provide additional coronavirus stimulus 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”) which will have implications for lenders, landlords, vendors and other creditors. Absent further legislation, these changes will sunset on December 27, 2022, but will continue thereafter to affect cases filed prior to that date.
- PPP Loans Still Aren’t For Everyone: CAA Attempts to Clarify Debtors’ Eligibility
The CARES Act, passed at the outset of the Covid-19 pandemic, did not make clear whether bankrupt debtors were eligible for the Paycheck Protection Program (“PPP“) loans it provided. The Small Business Administration (“SBA”), the agency charged with implementing the PPP loan program, previously promulgated regulations disqualifying all bankrupt debtors from the program, and it sought to enforce that regulation in the Bankruptcy Courts. Litigation ensued over debtor eligibility for PPP loans, but no clear consensus emerged.
The CAA attempts to bring certainty to whether debtors can qualify for PPP loans, but instead substitutes new uncertainty and additional obstacles. 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 amendments will only go into effect if the SBA determines that such 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 have to revise these guidelines, and the SBA does not appear to be under any pressure to do so.
If the CAA’s amendments do take effect, other procedural hurdles stand in the way of PPP eligibility for debtors. A debtor must seek bankruptcy court approval of any PPP loan, and the bankruptcy court must hold a hearing on the debtor’s application on an expedited seven day basis. If approved, a PPP loan would be treated as super-priority administrative expenses under sections 364(c)(1) and 503(b) of the Code—unless and until they are forgiven. Additionally, existing lenders to bankrupt debtors should be aware that contingent amendments to section 364 also provide that a debtor may obtain a PPP loan notwithstanding cash collateral or debtor-in-possession lending arrangements in place that would otherwise prohibit subsequent borrowing by the debtor. Furthermore, the Code’s relevant plan confirmation provisions would also be amended to permit confirmation of a plan that pays a PPP loan according to its terms notwithstanding the super-priority status of PPP loans in bankruptcy.
Certainly, businesses struggling through the pandemic and their lenders and stakeholders would benefit greatly from another round of relief funds. But the availability of such relief to debtors remains uncertain. Will the SBA directly respond to the CAA? Will the courts be asked to intervene and interpret the CAA to require that the SBA promptly initiate relief for these struggling debtors? These questions may not be answered without more litigation and confusion.
- Creditors Get Some Covid-Related Relief From Preference Liability
During the pandemic, extraordinary measures have been required and (in many cases) taken by creditors and their debtors to address their mutual financial challenges. Catch-up payments, renegotiated credit terms and other forms of forbearance have become the “new normal” between debtors and their trade vendors, service providers and landlords (among others). The unintended consequence of this new reality been to turn the notion of the “ordinary course of business” as a preference defense on its head.
Generally speaking, section 547 of the Code provides that preferences are payments made by a debtor to a creditor within ninety (90) days of such debtor’s bankruptcy filing which the debtor (or trustee) may, absent the existence of certain defenses, “claw back” into the bankruptcy estate. One of the few preference defenses creditors have is the so-called “ordinary course of business” defense.
Recognizing that circumstances created by the pandemic should not deprive creditors willing to work with debtors of an important preference defense, the CAA carves out a new preference defense aimed to protect deferred payments from a debtor after March 13, 2020. Specifically, the CAA modifies section 547 of the Code to prohibit lawsuits by a debtor (or trustee) against landlords to recover certain pre-bankruptcy payments under a contract or lease for “covered rental arrearages” and “covered supplier arrearages.” To qualify for this exemption, (a) the debtor and the landlord must have entered into a contract or lease before the bankruptcy filing, (b) they must have amended such contract or lease after March 13, 2020, and (c) the contract or lease amendment must have deferred or postponed payments otherwise due under the contract or lease. The preference exemption will not apply to the payment of fees, penalties, or interest imposed in the post-March 13, 2020 amendment. While this amendment will sunset on Dec. 27, 2022, it will continue to apply in any bankruptcy case that is commenced before the sunset date.
Although these changes are clearly designed to remove a potential preference penalty for creditors, and in turn incentivize them to agree to financial accommodations with their debtors amid pandemic-related business challenges, it remains to be seen whether these changes will actually confer a practical benefit upon creditors. Like any new law, this amendment may raise more questions than it answers, such as:
- What qualifies as an “agreement or arrangement”? And must it be in writing?
- Will a landlord, vendor or service provider lose protection if the debtor defaults under the “agreement or arrangement”?
- Should the “agreement or arrangement” be formally amended if the customer defaults?
- Can a new “agreement or arrangement” protect payments retroactively?
- Does an agreement that was entered into before March 13, 2020, prevent the parties from entering into a new agreement? Would a new agreement after March 13, 2020, be possible only if there was a material breach in a pre-March 13, 2020 agreement?
For leases and executory contracts that involve large monthly payments, the best practice may be to avoid these and any other questions to the extent possible by proactively entering into formal forbearance agreements that are designed specifically with the requirements of this new defense in mind.
- Other CAA Amendments Temporarily Codify Pandemic-Related Relief Previously Granted to Many Commercial Tenants – But At Landlords’ Expense
While landlords can take some solace in the changes to the preference law which may help them to preserve rent payments they receive, even under renegotiated lease terms, lenders are less likely to welcome other CAA changes to the Bankruptcy Code designed to give debtors more lease flexibility.
Subchapter V Debtors Will Have More Time to Perform Under Their Leases
The CAA modifies Section 365 of the Bankruptcy Code to amend the time period within which small business debtors must perform their lease obligations in Subchapter V bankruptcy cases. (Subchapter V only applies to so-called “small business debtors” debtors with “non-contingent” liabilities of $7,500,000 or less). Prior to the amendment, section 365(d)(3) provided generally that the debtor “shall timely perform” all lease obligations, subject to extension by the Court for cause. Such an extension could not extend beyond 60 days after the filing of the bankruptcy, although Courts extended these 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 permits the bankruptcy court to further extend the 60-day period for an additional 60 days if the Subchapter V debtor “is experiencing or has experienced a material financial hardship due, directly or indirectly, to the coronavirus disease 2019 (COVID-19) pandemic.”
The deferred rental payments 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 in the fact that these changes only apply to small business debtors, and after March 27, 2021, there will be fewer of them when the debt eligibility threshold for new subchapter V cases should revert from $7,500,000 to only $2,725,625.
All Bankrupt Debtors Will Have More Time to Assume or Reject Leases
Section 365(d)(4) of the Bankruptcy Code was also amended to extend the deadline for all debtors (this time not just subchapter V debtors) to assume or reject non-residential real property leases to 210 days (from 120 days under the prior law). However, this is not a significant departure from the Code or common practice. Under the prior law, the deadline could have been extended “for cause,” and during the pandemic such deadline was routinely extended. While the CAA codified the extended deadline, this was hardly a critical change.
In summary, while the CAA attempts to provide additional Covid-related relief to distressed businesses by “socially distancing” from the Bankruptcy Code, it remains to be seen whether any of these changes will provide tangible relief or if such relief is merely illusory. Your trusted legal advisors can help you manage any issues related to these changes.