Last week, in our first of what we expect to be many articles in the series “Bankruptcy On Ice”, we wrote about the unprecedented suspensions of proceedings enacted in several major chapter 11 bankruptcies in response to the temporary store closures and critical protective measures being imposed to fight the spread of COVID-19.
Decisions by the bankruptcy courts presiding over the Modell’s Sporting Goods, Pier 1 Imports, and Craftworks cases have demonstrated how far bankruptcy courts are willing to extend their equitable powers to put bankruptcy matters on ice while debtors are unable to conduct liquidation sales or otherwise advance their cases. Notably, until stores are allowed to reopen, some bankruptcy courts have allowed debtors to defer payment of post-petition rent under unexpired leases despite clear provisions in the Bankruptcy Code prohibiting such payment holidays.
First Crack in the Ice?
In the Forever 21 bankruptcy currently pending in the bankruptcy court for the District of Delaware, F21, the new purchaser of the debtor’s assets, asked the court to modify the bankruptcy sale order—specifically, to prevent landlords whose leases are “rejected” from disposing of inventory “until after the buyer has had a reasonable opportunity to either sell such property pursuant to a [going-out-of-business] sale or otherwise remove and dispose of the property in an orderly fashion in a reasonable period of time.” Simply put, F21 asked that it be allowed to keep its assets at, and in essence remain in possession of, leased premises rent-free while stores are closed due COVID-19 orders. F21 would only resume going-out-of-business sales once stores can be reopened, which would be consistent with the process set forth in the sale order.
On Tuesday, Judge Walrath of the U.S. Bankruptcy Court for the District of Delaware denied F21’s motion and refused to freeze rent payments. Unless landlords are returned to possession of their leased premises, Judge Walrath ruled, Forever 21’s rejection of such leases cannot be effective and such lease agreements must be honored. While the court acknowledged that the COVID-19 pandemic has caused terrible worldwide disruption, the court opined that it lacks the authority to override Section 365 of the Bankruptcy Code and therefore cannot simply freeze F21’s rent obligations. The Court stopped short of ruling on whether buyer F21 had any defenses to payment of rent under rejected leases as a result of losing any right to occupy leased premises.
Although Judge Walrath’s decision might have spared Forever 21’s landlords from the “deep freeze” blanketing the leased premises in the currently-suspended chapter 11 proceedings referenced above, skies remain cloudy at best. The fact that F21’s request for relief would have benefited itself, rather than the debtors themselves, clearly distinguishes that requested suspension from the typical orientation of the Bankruptcy Code.
Will the Ice Start Melting Sooner Than Expected?
On Monday, Modell’s Sporting Goods filed their notice of intent to seek a further suspension of their cases for another month (through May 31, 2020). Given that the court has already approved a deferral of April and May rent until August 1, based upon expected store reopenings in June, it seems likely that the court will extend the freeze.
That said, there have been numerous reports this week about states moving rapidly towards reopening businesses in phases and even relaxing some social distancing measures. Notably, Georgia Governor Kemp has announced that many businesses there can “reopen” by this Friday, while Governors on the other end of the spectrum have cautioned against reopening “too soon” (including Governor Cuomo of New York, Governor Pritzker of Illinois, and Governor Murphy of New Jersey, among others).
With the inability to freely conduct business due to mandated closures of non-essential businesses, including most if not all retail stores, courts seem willing to offer debtors more time by freezing chapter 11 proceedings. Should business reopen in some fashion, those reopenings could dramatically change the bankruptcy landscape sooner than expected. If stores, restaurants, health clubs, and movie theaters can reopen in May, we expect landlords and other post-petition creditors to immediately seek to melt these freezes while debtors try to keep things “on ice” a little while longer.
As always, Landlords and other potentially-affected creditors should seek sound counsel to weather this storm.
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