The CAA’s Impact On Commercial-Real-Estate Bankruptcies – Real Estate and Construction

To print this article, all you need is to be registered or login on Mondaq.com.

Late last year, President Trump signed into law the Consolidated
Appropriations Act (“CAA“), which
provided $900 billion in a second wave of economic stimulus
relief.1 The CAA, a nearly 5,600-page law,
supplements the Coronavirus Aid, Relief, and Economic Security Act
(the “CARES Act“) and amends several
provisions of the Bankruptcy Code. Some of the amendments benefit
commercial landlords, while others benefit business owner tenants.
These amendments are limited, however, in that they only apply to
bankruptcy cases that were commenced after December 27, 2020, and
they will sunset as discussed below.

Significantly, the CAA pre-dates the recently enacted American
Rescue Plan Act of 2021, which was signed into law by President
Biden on Thursday, March 11, 2021, and which we published a summary
of on Friday, March 12, 2021. Our analysis can be found here.

CAA REDUCES “PREFERENCE” EXPOSURE FOR ALL COMMERCIAL
LANDLORDS AND SUPPLIERS

The Bankruptcy Code provides certain causes of action by the
debtor against those creditors who may have received payment just
prior to the debtor’s bankruptcy case to ensure an equitable
distribution is ultimately made to all creditors. 
Specifically, the Bankruptcy Code provides that a debtor may
recover certain payments it made while it was insolvent during the
90 days prior to the date it files for bankruptcy (the
Commencement Date“) as a so-called
“preference.”2 During COVID, some
landlords agreed to defer commercial tenants’ rent. If a tenant
paid any of that deferred rent within the 90-day look-back period
and subsequently filed for bankruptcy, then the tenant’s (now
debtor’s) payment would be subject to avoidance (return) and
recovery.3 In other words, the debtor could
potentially “claw back” the deferred rent payments it
made 90 days prior to the Commencement Date to increase the
distribution made to all its creditors.

The CAA, however, temporarily amends this section of the
Bankruptcy Code, for the benefit of commercial lessors and, by
extension, the commercial lessees. The amendment limits a
debtor’s ability to “claw back” certain deferred rent
payments made within two years prior to the debtor’s filing for
bankruptcy as a preference.4 Effectively, this
eliminates preference risk for landlords who agree to defer rent
and whose tenants later file for bankruptcy. Under this amendment,
a commercial-rent deferral is defined as a “covered payment of
rental arrearages” and means a payment of arrearages that

  1. is made in connection with an agreement or arrangement (I)
    between the debtor and a lessor to defer or postpone the payment of
    rent and other periodic charges under a [commercial lease]; and
    (II) made or entered into on or after March 13, 2020;
  2. does not exceed the amount of rental and other periodic charges
    agreed to under the [commercial lease] described in clause (i)(I)
    before March 13, 2020; and
  3. does not include fees, penalties, or interest in an amount
    greater than the amount of fees, penalties, or interest (I)
    scheduled to be paid under the [commercial lease] described in
    clause (i)(I) or (II) that the debtor would owe if the debtor had
    made every payment due under the [commercial lease] described in
    clause (i)(I) on time and in full before March 13,
    2020.5

The theory is that this amendment will encourage landlords to be
more open to providing tenants with rent deferrals if their
exposure to a forced return of those funds in a tenant’s
bankruptcy case is eliminated.6 This amendment will
sunset on December 27, 2022.

CHANGES AFFECTING SUBCHAPTER V SMALL-BUSINESS TENANT-DEBTORS
WITH LESS THAN $7.5 MILLION IN DEBT

1. Subchapter V Debtors

On February 19, 2020, Congress enacted the Small Business
Reorganization Act of 2019 (the “SBRA“),
granting debtors the option to elect a new subchapter V of chapter
11 of the Bankruptcy Code (“Subchapter V
Debtor
“). The SBRA was enacted to provide
small-business debtors the opportunity to reorganize in a more
cost-effective manner than they otherwise would be able to under
the Bankruptcy Code. The Bankruptcy Code defines a “small
business debtor” as a “person (1) engaged in a commercial
business activity, excluding the ownership of single asset real
estate … (2) [that had] non-contingent liquidated secured and
unsecured debt as of the date of the filing of the petition [in an
amount] not more than $2,725,625 (excluding debts owing to
affiliates and insiders), and (3) the majority of such debts must
have arisen from the commercial or business activities of the
debtor.”7 The CARES Act increased the
$2,725,625 cap to $7,500,000, which is scheduled to sunset
on March 27, 2021.

Notably, the CAA did not extend the increase of the Subchapter V
Debtor cap. Therefore, after March 27, 2021, only debtors with
$2,725,625 or less in debt will qualify as Subchapter V
Debtors.

2. Increased Rent Deferral for Subchapter V
Debtors

The Bankruptcy Code provides that once a commercial tenant files
for bankruptcy, it must timely perform all of its lease obligations
pending its decision to assume or reject the
lease.8 A debtor-tenant may request that the
bankruptcy court permit it to defer paying its rent for 60 days
after the Commencement Date, which is routinely granted by a
bankruptcy court upon a showing of sufficient
cause.9

The CAA temporarily amends this section of the Bankruptcy Code
solely for Subchapter V Debtors. If a Subchapter V Debtor files for
bankruptcy because of coronavirus-related financial hardship, then
the CAA’s Bankruptcy Code amendment permits such businesses to
defer their rent to the earlier of (i) 120 days after they file for
bankruptcy (twice the time that the debtor would normally have) and
(ii) the debtor’s assumption or rejection of the commercial
lease.10 As a result, debtors have more flexibility
in paying their rent, while landlords assume the risk of providing
a further involuntary extension of credit (and tenancy) to the
debtor.

Any claims arising from the deferral of a debtor-tenant’s
rent under a commercial lease will be treated as an
“administrative expense” under the Bankruptcy Code.
Administrative expenses receive a special priority payment and are
paid before other general unsecured creditors. This amendment will
sunset on December 27, 2022.

3. Subchapter V Debtor-Tenant’s Time to Assume or
Reject a Commercial Lease Increased

Under the Bankruptcy Code, all debtors must determine whether to
assume or to reject a commercial lease by the earlier of (a) 120
days after the Commencement Date and (b) the date of the
confirmation of their plan of reorganization.11 The
bankruptcy court may may—and frequently does—extend the
120-day period on motion by the debtor by 90 days such that a
debtor has up to 210 days after the Commencement Date to determine
whether to assume or to reject a commercial
lease.12 Generally, if a debtor-tenant assumes its
commercial lease, then it may assign the lease notwithstanding any
provision in the lease that prohibits, restricts, or conditions the
assignment of that lease, provided that the assignee can adequately
demonstrate its ability to perform under the lease
terms.13 There are certain exceptions to a
debtor’s ability to assume and assign a shopping-mall
lease.14

The CAA’s Bankruptcy Code amendments, however, provide
Subchapter V Debtors with an additional 90 days to determine
whether to assume or to reject a commercial
lease.15 Therefore, Subchapter V Debtors have up to
300 days in which to determine whether to assume or to reject a
commercial lease, placing additional pressure on commercial
landlords. This amendment will sunset on December 27,
2022
.

Regardless of the CAA’s amendments to the Bankruptcy Code,
if a commercial lease is rejected in bankruptcy, then a
landlord’s rejection-damages claim is capped at an amount equal
to the greater of one year’s unpaid rent or “15% … not
to exceed 3 years” of the remainder of the lease
term.16

4. Subchapter V Estate Property Does Not Include
Pandemic-Relief Payments

Creditors, including commercial landlords, look to recover on
account of their claims from available assets that qualify as
property of the debtor’s bankruptcy estate. 
“Property of the Estate” is broadly defined under the
Bankruptcy Code, and generally includes all of the debtor’s
legal and equitable interests in property on the commencement of
the bankruptcy case.17 The CAA amends the
Bankruptcy Code to provide that pandemic-relief payments
are not property of the
debtor’s estate.18 As a result of this
revision, pandemic-relief payments will not be available to satisfy
obligations owed to creditors. This amendment will sunset
on December 27, 2021.

5. Subchapter V Debtors Eligible for Paycheck Protection
Program
 Loans

The CARES Act led to significant litigation over its exclusion
of bankruptcy debtors from being considered for Paycheck Protection
Program (“PPP“) loans. Effectively,
debtors were prohibited from obtaining PPP
loans.19 The CAA does not remedy the existing
litigation related to the CARES Act’s exclusion of debtors
getting PPP Loans. Instead, the CAA permits certain debtors to
obtain PPP loans if they file for bankruptcy after December 27,
2020. Specifically, the Bankruptcy Code was amended to authorize
PPP Loans to (i) Subchapter V Debtors, (ii) chapter 12 debtors
(farmers), and (iii) chapter 13 debtors. Notably, the CAA excludes
by omission chapter 11 debtors. This amendment will sunset
on December 27, 2021.

6. Nondiscrimination Against Subchapter V Debtors Who
Have Previously Received Aid Under the CARES Act

The CAA prohibits a landlord from utilizing a
tenant-debtor’s recent or current bankruptcy as the basis for
denying a tenant’s relief afforded by the CARES Act including
the (i) foreclosure moratorium, (ii) provision providing for
forbearance of residential-mortgage-loan payments for multifamily
properties with federally backed loans, and (iii) temporary
moratorium on eviction filings. This modification of the Bankruptcy
Code is set to expire on December 27,
2021
.20

Footnotes

1 Note, we previously have published a summary of the CAA
which can be found here. This Alert specifically focuses on
amendments the CAA made to the Bankruptcy Code and their impact on
commercial real estate, which has been slow to recover from the
pandemic’s effects.

2 11 U.S.C. § 547. A “preference” is (a) a
payment on an “antecedent” (meaning a previously
incurred, as opposed to current) debt (b) made while the debtor was
insolvent (c) to a non-insider creditor, within 90 days of the
filing of the bankruptcy, (d) that allows the creditor to receive
more on its claim than it would have had the payment not been made
and the claim paid through the bankruptcy proceeding. Section 550
of the Bankruptcy Code allows the trustee to avoid and recover any
preference payments by filing a lawsuit against the creditor. The
Bankruptcy Code presumes that a debtor was insolvent if it receives
a payment during this 90-day period, thus shifting the burden to
the landlord to prove that the tenant was not insolvent. Under the
Bankruptcy Code, a debtor is generally considered to be insolvent
if its debts exceed its assets on the day that it files for
bankruptcy protection. There are several defenses to preferences
that landlords and other commercial counterparties regularly employ
that are beyond the scope of this alert.

3 Id.

4 CAA § 1001(g).

5 Id.

6 Section 1001(g) of the CAA offers similar protections
for certain suppliers who agreed to defer a debtor’s payments
because of financial hardship caused by COVID. Like the
requirements for a landlord to take advantage of this amendment,
such supplier deferrals are defined as “covered supplier
arrearages” and mean a payment of arrearages that

  • is made in connection with an agreement or arrangement (I)
    between the debtor and a supplier of goods or services to defer or
    postpone the payment of amounts due under an executory contract for
    goods and services and (II) made or entered into on or after March
    13, 2020;
  • does not exceed the amount due under the executory
    contract described in clause (i)(I) before March 13, 2020;
    and
  • does not include fees, penalties, or interest in an amount
    greater than the amount of fees, penalties, or interest (I)
    scheduled to be paid under the executory contract described in
    clause (i)(I) or (II) that the debtor would owe if the debtor had
    made every payment due under the executory contract described in
    clause (i)(I) on time and in full before March 13, 2020.

7 11 U.S.C. § 101 (51D).

8 11 U.S.C. § 365(d)(3).

9 Id.

10 CAA § 1001(f).

11 11 U.S.C. § 365(d)(4).

12 Id.. Typically, courts extend this deadline for
debtors, but the net effect is that commercial tenants must decide
whether to assume or to reject a commercial lease within 210 days
after filing for bankruptcy.

13 11 U.S.C. § 365(f)(1). Significantly,
contract provisions that declare a default in the event of
insolvency or bankruptcy, or would otherwise affect and/or waive
the rights of a debtor in bankruptcy, called ipso
facto clauses, are generally unenforceable.

14 Under § 365(b)(3), to demonstrate adequate
assurance of future performances, an assignee of a lease in a
shopping mall must demonstrate

  • adequate assurance of the source of rent and other
    consideration due under that lease and, in the case of an
    assignment, that the financial condition and operating performance
    of the proposed assignee and its guarantors, if any, shall be
    similar to the financial condition and operating performance of the
    debtor and its guarantors, if any, as of the time the debtor became
    the lessee under the lease;
  • that any percentage rent due under that lease will not
    decline substantially;
  • that assumption or assignment of that lease is subject to
    all the provisions thereof, including (but not limited to)
    provisions such as a radius, location, use, or exclusivity
    provision, and will not breach any such provision contained in any
    other lease, financing agreement, or master agreement relating to
    such shopping center; and
  • that assumption or assignment of that lease will not
    disrupt any tenant mix or balance in the shopping
    center.

15 CAA § 1001(f).

16 11 U.S.C. § 502(b)(6).

17 11 U.S.C. § 541(b).

18 CAA § 1001(a).

19 Debtors asserted that excluding them from obtaining
PPP loans violated § 525 of the Bankruptcy Code. Section
525 provides debtors with protection from discrimination by (a)
governmental units, (b) private employers, and (c) governmental
units and private entities operating student-loan programs. The
discrimination must be due solely to the fact that the debtor filed
for bankruptcy, was insolvent, or failed to pay discharged
debts.

20 CAA § 1001(c).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.