Business owners and tenants: take note of these changes to the Bankruptcy Code – Real Estate and Construction

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United States: Business owners and tenants: take note of these changes to the Bankruptcy Code

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With COVID-19 cases continuing to remain high and hospitals at or above capacity, we may soon see the return of full or partial lockdown. This means that businesses will once again struggle to make ends meet and bankruptcy filings could be on the rise. Significant changes were made to the bankruptcy code at the end of 2020 when Congress enacted the Consolidated Appropriations Act of 2021 (the “Act“) to provide much needed COVID-19 relief to individuals and businesses. The law provided for nine changes to the bankruptcy code, but this article focuses on three that relate to commercial leases. Should be taken into account when landlords and commercial tenants undertake rent relief discussions, as understanding the ramifications of filing for a tenant’s bankruptcy can help determine which accommodations to consider.

Extension of the period of execution of rental obligations. The first change made by the Act is the extension of the period for fulfilling obligations to lease non-residential property. Under section 365 of the Bankruptcy Code, a trustee is required to perform all of the debtor’s obligations under an unmatured lease of non-residential property from the date the reorganization order is issued. entry until the lease is accepted or rejected. 11 USC § 365 (d) (3) (A). This period of execution may be extended by the court for a period of 60 days for a demonstrated just cause. Identifier. Under the changes made by the law, the court can extend the period of execution for an additional period of 60 days (total of 120 days) “if the debtor continues to experience significant financial hardship due, directly or indirectly, to the debtor. [COVID-19] pandemic[.]”
Identifier. § 365 (d) (3) (B) (i). This additional 60-day extension can only be used by small business debtors under Chapter 11, Subchapter V.

Business owners should take this into account when discussing rent deferral or reduction with small business tenants. Under the Act’s amendments to section 365 (d) (3), a small commercial tenant could stay on the premises without fully complying with the terms of the lease for up to 120 days. For example, if the exemption order is entered on October 1, 2021, the trustee could have until January 29, 2022 to fully meet all rental obligations.

Extension of the period to assume or reject the unexpired lease. The second change made by the Act is the extension of the time limit for taking over or rejecting an unexpired lease of a non-residential building. One of the most powerful tools in bankruptcy is the debtor’s ability to reject unwanted enforceable contracts, including unexpired leases. Before 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 a non-residential building under which the debtor is the tenant. 11 USC § 365 (d) (4) (A) (i). The 120 days could be extended for another 90 days by court order. Identifier. § 365 (d) (4) (B) (i). If the trustee did not do so, the lease was deemed to be rejected and the trustee had to immediately transfer the property to the lessor. Identifier. § 365 (d) (4) (A) (i).

The Act extended to 210 days the period during which a trustee can assume or reject an unexpired lease of a non-residential building. 11 USC § 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 exemption order is entered on October 1, 2021, a trustee could have until July 28, 2022 to assume or reject an unexpired lease. It’s a long time for owners to stay in limbo. Unlike the amendment to section 365 (d) (3), the 210-day extension applies to all debtors.

“Rent Arrears Covered Payments” are no longer considered a preference and cannot be recovered. Perhaps the most significant change for business owners is the change to section 547 which deals with preferences. Under section 547, a trustee may avoid certain transfers of assets to creditors made in the ninety days preceding the filing of the bankruptcy petition, with a few exceptions. 11 USC § 547 (b) (2020). The law added to these exceptions “the payment of rent arrears”.
Identifier. § 547 (j) (2) (A). A “covered payment of rent arrears” is (1) an arrears payment (2) made under an agreement (3) between the debtor and the landlord “to defer or defer the payment of rent or ‘other periodic charges under a lease for non-residential buildings’ (4) entered into or concluded on or after March 13, 2020. Identifier.§ 547 (j) (1) (A) (i). Although the covered payments may include fees, penalties or interest, these amounts cannot exceed the amounts provided for under the lease or what the debtor would have owed had it been up to date on March 13, 2020. Identifier. § 547 (j) (1) (A) (ii). This change prompts commercial landlords to allow flexible payments from troubled tenants by assuring the landlord that those payments will not be clawed back if the tenant ends up declaring bankruptcy. As with the extension of the 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 end on December 27, 2022.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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