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25 January 202110 minute read

The Consolidated Appropriations Act of 2021: Temporary amendments to the Bankruptcy Code

On December 27, 2020, President Trump signed into law the Consolidated Appropriations Act of 2021 (CAA), the omnibus funding bill that makes consolidated appropriations for the fiscal year ending September 30, 2021. The CAA also provides various forms of economic relief to address the effects of the COVID-19 pandemic.

As part of its coronavirus response, the CAA includes a number of amendments to the Bankruptcy Code. The key amendments are addressed below.

Temporary statutory protection of certain arrearage repayments under forbearance arrangements

The amendment that will positively impact many businesses, regardless of size and industry, is the amendment to section 547 of the Bankruptcy Code, which permits a debtor in possession or trustee to recover so-called preferential payments.  The amendment to section 547 expressly protects lessors of nonresidential real estate and suppliers of services and goods from claw backs of “covered” arrearage repayments made pursuant to forbearance or deferment arrangements entered into as a result of the coronavirus pandemic on or after March 13, 2020.  It is important to note that the language of the amendment does not apply to lessors of personal property, such as machinery, equipment or furniture.

By way of background, section 547(b) of the Bankruptcy Code authorizes a debtor in possession or trustee to claw back prepetition payments made by the debtor to its creditors 90 days prior to bankruptcy or 1 year if the payment was made to an insider.  Prepetition payments are not automatically preferential as, in order to claw back a prepetition payment, a debtor in possession or trustee must demonstrate that:

  1. the transfer was made for the benefit of a creditor;
  2. the transfer was made for or on account of an antecedent debt owed by the debtor before the transfer was made;
  3. the transfer was made while the debtor was insolvent (which is presumed during 90 days immediately preceding the date of the bankruptcy filing;
  4. the transfer was made 90 days before the date of the bankruptcy filing (or 1 year if the transfer was made to an insider); and
  5. the transfer enabled the creditor to receive more than it would receive in a chapter 7 liquidation (which is almost always satisfied).

Nevertheless, the preference elements are relatively easy to satisfy. Thus, preference defendants often must rely on one or more of the affirmative defenses to a preference claim to protect the preferential payments, most frequently invoking such affirmative defenses as the ordinary course defense, the new value defense and the contemporaneous exchange for new value defense. 

Importantly, the affirmative defenses listed above typically are not available to a creditor if the debtor-counterparty was in financial distress and, therefore, failed to pay its debts to the creditor when due.  Accordingly, creditors that are willing to provide forbearance or deferral accommodations to their business counterparties in distress often find themselves not only as defendants in preference lawsuits but also without any available affirmative defense that would shield the arrearage repayments from being clawed back.  The CAA amendment to section 547 of the Bankruptcy Code changes this seemingly inequitable result, recognizing the benefits of and the need for protecting the arrearage repayments made pursuant to forbearance and deferral arrangements.

Indeed, many lessors and suppliers are more than willing to provide breathing room for their business counterparties (with which they may have worked for decades), yet they choose not to do so solely because they do not want to strip themselves of the affirmative defenses and effectively end up paying for their commercial flexibility.  Of note, even if the relationship of a lessor or supplier with its business counterpart is long and trusting, the business counterparty may not be the one making the decision once in bankruptcy regarding whether to commence a preference action as a liquidating trustee or a chapter 7 trustee may be incumbent and, thus, have the sole power to do so; this management displacement complication historically has discouraged lessors and suppliers to enter into forbearance or deferment arrangements.  Thus, the amendment encourages lessors and suppliers to provide an often-needed reprieve to their business counterparties with respect to financial performance under real estate leases and supply agreements, potentially enabling their business counterparties to bridge to a more normalized, post-pandemic environment and avoid bankruptcy (or at a minimum, not forcing their counterparties in distress into bankruptcy).

Under the new amendment, in order for rent arrearage repayments to fall within the definition of “covered payment of rental arrearages” that may not be clawed back (or avoided) as preference, such a payment of arrearages (i) must be made pursuant to an agreement or arrangement entered into on or after March 13, 2020, between the debtor and a lessor to defer or postpone the payment of rent and other periodic charges under an unexpired lease of nonresidential real property; (ii) cannot exceed the amount of rental and other charges due under the lease agreement that was executed before March 13, 2020; and (iii) cannot include fees, penalties or interests greater than the amount of fees, penalties or interest scheduled to be paid under the lease agreement or that the debtor would owe if it was timely on its payments.

The language of the amendment with respect to “a covered payment of supplier arrearages”  – that likewise may not be avoided as a preference – mirrors the language regarding covered payments of rental arrearages.  Specifically, in order to be deemed a “covered payment of supplier arrearages,” a payment of arrearages (i) must be made pursuant to an agreement or arrangement entered into on or after March 13, 2020, between the debtor and a supplier of goods or services to defer or postpone the payment of amounts due under an executory supply agreement; (ii) cannot exceed the amounts due under the supply agreement that was executed before March 13, 2020; and (iii) cannot include fees, penalties or interests greater than the amount of fees, penalties or interest scheduled to be paid under the supply agreement or that the debtor would owe if it was timely on its payments.

The above amendment sunsets on December 27, 2022 (two years from the date of its enactment) but may be utilized in any bankruptcy case commenced before the sunset date.

Many, on each side of the negotiating table, remain hopeful that this piece of legislation becomes a permanent provision of the Bankruptcy Code after, hopefully, the positive effects thereof come to light before the sunset date. 

Temporary extension of time for debtor-tenants to decide whether to assume or reject certain leases

Another temporary amendment implemented through the CAA is to section 365(d)(4) of the Bankruptcy Code, which provides a debtor-tenant with a specific timeline within which the debtor-tenant must decide whether to assume (reaffirm) or reject (terminate) its nonresidential real property leases.  Specifically, section 365(d)(4) of the Bankruptcy Code (as amended by the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)) provides a debtor-tenant with 120 days after the bankruptcy filing to assume or reject a nonresidential real estate lease, subject to an additional 90-day extension upon bankruptcy court approval.  If the bankruptcy court approves such an extension, then the bankruptcy court may grant a subsequent extension but only if the debtor obtains the lessor’s prior written consent.  The CAA extends the initial 120-day period within which the debtor-tenant may assume or reject the lease to 210 days.  Accordingly, given that the debtor motions seeking an additional 90-day extension are routinely granted by bankruptcy courts, the CAA effectively provides debtor-tenants with at least 210 days and very likely 300 days or even more to make the determination.

This amendment is not surprising: even in a more normalized, pandemic-free business environment, debtor-tenants in a free-fall bankruptcy more often than not seek an additional 90-day extension in order to have ample time either to formulate a restructuring exit plan or to find a purchaser for their assets that ultimately will dictate whether to assume or reject the debtors’ leases.  In a pandemic-ridden business environment, when the future of a business is uncertain, to say the least, the importance of the additional time is critical.  Thus, from the debtor perspective, the extension of the period via the CAA is appropriate and congruent with the bankruptcy practice, although it leaves lessors in limbo for a bit longer.  Interestingly, this is the second (although temporary) legislative extension of time for the assumption or rejection of nonresidential real estate leases –prior to BAPCPA, debtor-tenants had only 60 days from the bankruptcy filing within which to assume or reject unexpired nonresidential real estate leases, subject only to the additional 60-day period upon bankruptcy court approval.

Temporary extension of time for small business debtor-tenants to perform under certain leases

The CAA provides a further reprieve to small business debtor-tenants that commence a bankruptcy case under subchapter V of chapter 11 of the Bankruptcy Code (currently, a debtor may be eligible for subchapter V relief if it has no more than $7.5 million of noncontingent, liquidated, secured and unsecured debt).  Specifically, under section 365(d)(3) of the Bankruptcy Code, debtor-tenants generally must timely perform their obligations under nonresidential real estate leases; bankruptcy courts, however, may extend “for cause” the time for performance that arise within 60 days from the bankruptcy filing but only up to 60 days.  The CAA now allows small business debtor-tenants to seek an extension of rent payments under the lease for up to 120 days (rather than 60 days) if the debtor-tenant “is experiencing or has experienced a material financial hardship due, directly or indirectly, to the coronavirus disease.”

This amendment is significant in its express language as well as in what it omits.  In other words, the coronavirus-related relief has been extended only to small business debtors, which effectively excludes all other debtor-tenants.  The limited operation of the amendment may come as a surprise to many, given it comes on the heels of numerous filings by mid-market, large and mega tenants that requested the extension of performance under their nonresidential real estate leases, which were routinely granted (although not without admonitions) by bankruptcy courts across the country.  Rest assured, the limited application is welcomed by landlords, many of which have suffered substantial losses during the pandemic in large part due to the rent abatements, rent deferrals as well as tenant and rent loss altogether.

Both amendments, to subsections 365(d)(3) and (d)(4) of the Bankruptcy Code, sunset on December 27, 2022.

Learn more about the implications of these developments by contacting either of the authors or your DLA Piper relationship partner.