In April 2020, the federal government and other jurisdictions announced moratoriums on rental property evictions, but offered no financial assistance to unpaid landlords. Since then, many owners have rightly complained: “What about us?
Then, just before Christmas, the 2021 Consolidated Finance Law (CAA 2021) was enacted, with several bankruptcy amendments related to leases and rents. While the changes appear to provide a little balm for business owners, they extend post-petition limbo for owners of non-residential properties. CAA 2021 will leave many landlords with bankrupt tenants who are still wondering “What about us?” “
A Christmas gift from Préférence Défense
In bankruptcy, a trustee or debtor can avoid or recover payments the debtor made before declaring bankruptcy. Among other requirements, this cancellation power is limited to payments made during the 90-day period (or one year for insiders) preceding the bankruptcy on a history, or pre-existing, debt over $ 6,825. These preferential shares are quite common in the event of bankruptcy. Of the 1,263 adversarial proceedings, or bankruptcy lawsuits, filed with the Delaware District Bankruptcy Court in 2019, 72% were preferred shares. Likewise, a significant percentage of adversarial proceedings in the Southern District of New York (54%) and the Southern District of Texas (29%), both popular places for business bankruptcies, were also preference cases.
The CAA 2021 amendments specifically exempt certain “payments covered by rental arrears” from the recovery as preferential transfers as long as the amounts mainly relate to rents for non-residential properties, deferred from March 13, 2020, and do not exceed the amount of rents due under the lease before this date.
A nicely wrapped but empty box?
At first glance, this seems like a godsend for long-suffering owners. Homeowners could, in theory, be paid in full and narrowly escape avoidance by relying on this new affirmative defense. In reality, however, owners are rarely targeted to avoid preferential transfers. Nationally, fewer than 20 adversarial proceedings have been filed in the past decade to recover preferential payments related to commercial rent payments, and these have been almost exclusively filed in Chapter 7 cases.
Several reasons can explain the disproportionate number of preferential shares concerning rents. First, some tenant-debtors prioritize rent even in times of distress, and timely rent payments would not be considered preferential transfers. In addition, bankruptcy offers a unique advantage to tenants: the ability to assume or reject unexpired leases. Tenants of commercial property are generally knowledgeable enough to determine the feasibility of assuming or rejecting a lease before declaring bankruptcy. Most of those tenant-debtors who expect to turn down a lease will not pay months of rent arrears on the eve of bankruptcy; therefore, these unpaid owners have no preferential exposure. For landlords of tenant-debtors who are in arrears with the rent but are considering taking over the lease, there is “Defense of the Kiwi,“ which provides that unsecured creditors whose debts are paid in full, after the request and with the appropriate authorization of the court (for example, assumption of the lease), cannot then be sued for preferential transfers. Therefore, if a debtor pays a landlord past due rents on the eve of bankruptcy and then assumes the lease, the landlord will likely still have no preferred exposure.
As a result, there are few realistic scenarios in which homeowners would even have the opportunity to invoke CAA 2021’s new preference defense.
The new preference defense also has limitations. The covered payment cannot exceed the amounts that would normally be due under the lease as it existed. before March 13, 2020. In addition, the “covered payment” cannot include “fees, penalties and interest” in addition to what would normally be due under the lease if the debtor paid on time. Therefore, if the landlord has charged the tenant something more for the rent deferral, those charges are vulnerable to clawback.
And a piece of coal too ?!
While the new CAA 2021 preferential transfer amendment will likely have limited value for business owners, other bankruptcy amendments actually extend landlord misery to defaulting and non-paying tenants.
Debtors who file Chapter 11 under Subchapter V now have an additional 60 days, for a total of 120, to pay post-petition rent, and non-residential tenants in any event have an additional 90 days to pay. or reject the lease. Congress likely extended these deadlines to give small, bankrupt businesses more time to reorganize. However, for homeowners who are also struggling to pay off their mortgages and maintain their properties during the pandemic, these extensions make that problem worse by preventing the landlord from filling that space with a reliably paying tenant.
Only time will reveal the true utility of the amendments. Perhaps there aren’t as many potential tenants breaking down doors to occupy non-residential spaces, and landlords will benefit from debtors having more time to pay rent. The predicted “eviction tsunami” could materialize and lead to an increase in preferential actions targeting landlords and overdue rent payments, and many landlords will be able to protect themselves with this new affirmative defense.
But at this point, we just don’t find these CAA 2021 bankruptcy changes to be nearly as beneficial to the targeted demographic such as, for example, the amendments to subchapter V of the CARES Act. How homeowners fare under these changes will be a trend to watch until the changes expire in two years.
Bloomberg Law subscribers can find related content on our Comparison table – Temporary provisions of the Bankruptcy Code related to a pandemic.
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