Demystifying the Bankruptcy Process – Part Five

The COVID-19 pandemic has created a lot of turmoil in every industry and every company. For the last five months at least 171 companies in the energy, transportation, entertainment, health & personal care, retail,  travel, lodging and leisure industries have cited Covid-19 as a factor in decision for bankruptcy.

The risk of dealing with a company in a financial distress is at all times high. Understanding the bankruptcy tools available to a company that is on the path to or already in a court-supervised reorganization can help you in managing and reducing this risk.

Reorganizations in a Nutshell: Chapter 11 of the Bankruptcy Code governs the restructuring of businesses and individuals’ assets and liabilities. It provides financially distressed companies and individuals with protections that are attractive for the debtor and unavailable in many other jurisdictions. Among the key benefits of the US reorganization regime are:

• the management stays in control of the company and an outside trustee/administrator is not brought in unless there are extraordinary circumstances.
• the company can cherry pick beneficial contracts and reject burdensome ones.
• the company can sell its business, selected business lines or individual asses free and clear of any encumbrances or interests.

Chapter 11 filers choose to opt for bankruptcy relief for various reasons: to stop debt collection action, to revise unworkable capital structure, to address overwhelming litigation, to facilitate the sale of major assets to a prospective buyer, and to reject burdensome contracts, to name a few.

Chapter 11 brings all stakeholders to one forum and facilitates global resolution of claims and liabilities. It may have a different impact on the different stakeholders and these mini-series will cover the impact of a bankruptcy proceeding on trade creditors, distressed asset buyers, landlords, and the art world. The final summary is intended to help small business owners better understand how valuable a tool chapter 11 can be during a time of crisis by availing themselves of the new restructuring mechanism for businesses (and individuals with business debt) with undisputed liabilities that do not exceed $7.5 million.

What If You Are A Landlord?

If you find yourself a landlord of a company that filed for a Chapter 11 protection, you can enjoy some unique rights that put you in a better position than a typical unsecured creditor.

1. In theory, debtors must timely perform their lease post-petition and pre-rejection. Pre-petition defaults must be cured in order to assume and assign.
2. Leases cannot be crammed down or restructured
3. A landlord is entitled to adequate assurance of future performance.

However, exercising those rights requires vigilance because of highly accelerated sales proceedings and DIP Orders.

Risks:

1. Pre-bankruptcy termination is difficult and may be set aside by the bankruptcy court. Lease Termination Fee may be viewed as a preference or fraudulent conveyance.
2. In sales orders or DIP financing orders, there may be waiver of contractual restrictions – which may impact easement agreements, covenants, conditions and restrictions in leases.
3. Treatment of post-petition rent – per Section 365(d)(3) states that a debtor need only “timely perform” obligations which arise after the order for relief, that is post-petition obligations. Some courts hold the rent obligation arises on the billing date, when it is due to be paid. So, if rent is due on March 1, and debtor files on March 2, the entire March rent is treated as pre-petition rent under this rule.
4. Debtor calls the shots – whether to assume or reject the contract
5. Debtor is entitled to assume despite defaulting on the lease and despite of any contractual clauses contrary to that – the Bankruptcy Court in effect provides a federal cure right.
6. Debtor can assign the lease despite anti-assignment clauses.

Damages on rejected leases are capped – the greater of one-year rent or 15% of the remaining term (not to exceed 3 years).

In case you missed it, read part one, two, three, and four here.