With COVID-19 cases continuing to stay high and hospitals at or above capacity we may soon see the return of a full or partial lockdown. That means that businesses will again be struggling to make ends meet and bankruptcy filings may be on the rise. Some important changes were made to the bankruptcy code at the end of 2020 when Congress signed into law the Consolidated Appropriations Act of 2021 (the “Act”) to provide much needed COVID-19 relief to individuals and businesses. The Act included nine changes to the Bankruptcy Code, but this article focuses on three which pertain to commercial leases. These changes should be heeded as commercial landlords and tenants undertake rent relief discussions as understanding the ramifications of a tenant’s bankruptcy filing may help inform what accommodations should be considered.
Extension of time for performance of lease obligations. The first change made by the Act is the extension of the time for performance of nonresidential property lease obligations. Under Section 365 of the Bankruptcy Code, a trustee is obligated to perform all of the obligations of the debtor under an unexpired lease of nonresidential property from the date the order for relief is entered until the lease is assumed or rejected. 11 U.S.C. § 365(d)(3)(A). This time for performance may be extended by the court for a 60-day period for good cause shown. Id. Under the amendments made by the Act, the court may extend the time for performance for an additional 60-day period (total of 120 days) “if the debtor is continuing to experience a material financial hardship due, directly or indirectly, to the [COVID-19] pandemic[.]” Id. § 365(d)(3)(B)(i). This additional 60-day extension may only be utilized by small business debtors filing under Chapter 11, subchapter V.
Commercial landlords should take this into consideration when discussing rent deferral or abatement with small business tenants. Under the changes made by the Act to Section 365(d)(3), a small business commercial tenant could remain in the premises without fully complying with the terms of the lease for up to 120 days. For example, if the order for relief is entered on October 1, 2021, the trustee could potentially have until January 29, 2022 to fully perform all the lease obligations.
Extension of time to assume or reject unexpired lease. The second change made by the Act is the extension of time to assume or reject an unexpired lease of non-residential real property. One of the most powerful tools of bankruptcy is the ability of the debtor to reject undesirable executory contracts including unexpired leases. Prior to the Act, a trustee had up to 120 days or the date of entry of an order confirming a plan to assume or reject an unexpired lease of non-residential real property under which the debtor is the lessee. 11 U.S.C. § 365(d)(4)(A)(i). The 120 days could be extended for an additional 90 days by order of the court. Id. § 365(d)(4)(B)(i). If the trustee did not do so, the lease was deemed rejected and the trustee would have to immediately surrender the property to the lessor. Id. § 365(d)(4)(A)(i).
The Act extended the time in which a trustee may assume or reject an unexpired lease of non-residential real property to 210 days. 11 U.S.C. § 365(d)(4)(A)(i) (2020). With the additional 90 day extension, a trustee could have up to 300 days to assume or reject an unexpired lease. For example, if the order for relief is entered on October 1, 2021, a trustee could potentially have until July 28, 2022 to assume or reject an unexpired lease. That is a long time for landlords to remain in limbo. Unlike with the amendment to Section 365(d)(3), the extension to 210 days applies to all debtors.
“Covered payments of rental arrearages” no longer considered a preference and cannot be clawed back. Perhaps the most important change for commercial landlords is the change to Section 547 which addresses preferences. Under Section 547, a trustee may avoid certain transfers of assets to creditors made in the ninety days prior to the filing of the bankruptcy petition with some exceptions. 11 U.S.C. § 547(b) (2020). The Act added to these exceptions “covered payment of rental arrearages.” Id. § 547(j)(2)(A).
A “covered payment of rental arrearages” is:
- A payment of arrearages
- Made in connection with an agreement
- Between the debtor and landlord “to defer or postpone the payment of rent or other periodic charges under a lease of nonresidential real property”
- Made or entered into on or after March 13, 2020. Id. § 547(j)(1)(A)(i).
While covered payments may include fees, penalties, or interest, these amounts cannot exceed the amounts provided for under the terms of the lease or what the debtor would have owed if it was current as of March 13, 2020. Id. § 547(j)(1)(A)(ii). This change incentivizes commercial landlords to allow flexible payments from distressed tenants by assuring the landlord that those payments will not be clawed back if the tenant ends up filing for bankruptcy. Like with the extension of time to assume or reject unexpired leases, this change applies to all debtors, not just Chapter 11 small business debtors.
These changes are currently scheduled to sunset on December 27, 2022.
This article was published as part of the Fall/Winter 2021 issue of ke kumu, Cades Schutte’s client newsletter. Read the full publication of ke kumu, which explores some of the laws unique to Hawai‘i.