IMPACT OF NONRESIDENTIAL RENT DEFERRALS ON BANKRUPTCY FILINGS
Throughout the COVID-19 pandemic, commercial tenants have requested deferrals in the payment of accruing rent due to landlords. Many of our clients have sought our advice on how to minimize the risk that the repayment of deferred rent might later be subject to avoidance as preferential transfers, and subject to disgorgement, in the event the tenant later filed for bankruptcy during the repayment period and subsequently rejected the lease.
Under Bankruptcy Code section 547, a bankruptcy trustee or debtor-in-possession bankruptcy court may “claw back” certain out-of-the-ordinary payments made in the months leading up to a bankruptcy filing. Under the prior version of the statute, repayment of previously deferred rent received by a landlord within 90 days before the date of the filing of the bankruptcy, when the debtor is presumptively insolvent, would potentially be subject to avoidance, and recapture as an avoidable preference.
A typical rent deferral agreement would be as follows: Landlord and tenant agreed to defer April, May, and June 2020 rent and charges, to be re-paid over six months starting January 1, 2021 (i.e., starting January 1, the tenant would be paying regular rent and a ½-month “catch-up” payment each month). The rent deferral/catch-up portion of the payment would potentially be a preferential transfer under Bankruptcy Code section 547. If the tenant filed bankruptcy in April 2021 and did not assume the lease, as many as three of the catch-up payments of deferred rent (those received by the landlord in the 90 days prior to the bankruptcy) would potentially have to be repaid back to the bankruptcy estate as avoidable preferences.
LANDLORDS INCENTIVIZED TO PROVIDE FLEXIBLE TERMS TO DISTRESSED TENANTS
These “claw back” liability concerns potentially chilled rent deferral transactions or caused landlords to try and minimize preference exposure by agreeing to shorter repayment periods than might otherwise be desired by tenants. The Act amends Bankruptcy Code section 547 to create a temporary exception from the avoidance of preferential payments, protecting the landlord’s receipt of deferred payments made under rent deferral agreements made after March 13, 2020. This exception for “covered rental arrearages” is designed to incentivize landlords to provide flexible financing terms to distressed tenants without the risk that concessions previously made, or to be granted, in a time of crisis, will reduce the revenue to landlords should a tenant later file for bankruptcy and a claim is subsequently made for repayment.
To qualify for protection under amended Section 547, (1) the landlord and debtor-tenant must have been parties to an existing nonresidential lease, and (2) an amendment to the lease or other agreement for the deferral of rent was made after March 13, 2020, and (3) the amount of deferred rent “does not exceed the amount of rental and other periodic charges agreed to” under the existing lease. This exception for “covered rental arrearages” does not include, however, any fees, penalties, or interest in an amount greater than the fees, penalties, or interest “that the debtor would owe if the debtor had made every payment due under the lease of nonresidential real property ... on time and in full before March 13, 2020.” This amendment to Section 547 is beneficially structured as an exclusion from the definition of a potential preferential transfer underlying a trustee or debtor-in-possession’s prima facie case rather than an affirmative defense (on which a landlord would otherwise have the burden of proof and expense of litigating).
This amendment “sunsets” two years after its enactment, but the provisions will continue to apply to any bankruptcy case commenced before the sunset date (i.e., cases filed on or before December 27, 2022).
ALLEN MATKINS INVOLVEMENT
Ivan Gold, with a drafting assist from Michael Greger, was instrumental in this amendment. Following a number of client questions regarding potential preference liability early in the COVID-19 crisis, Ivan directly reached out to his contacts at the International Council of Shopping Centers (ICSC) regarding a potential change in the law. Working with ICSC, Ivan was part of communications with Congressional staff regarding the statutory language and related amendments that had been proposed to Bankruptcy Code section 365. The draft amendment was initially part of legislation introduced by Senator Thom Tillis (R-NC) in August and was later included in the ultimate COVID relief package contained in the Act, passed by the House and Senate on December 22 and signed into law by the President on December 27, 2020.