Unprecedented times call for unprecedented solutions. This has never been more true than now as our world struggles through impactful changes to our lives, both at work and at play, as a direct result of the COVID-19 pandemic. As social distancing, stay-at-home orders, and sheltering-in-place have forced the closing of shopping centers and retail stores, bars and restaurants, movie theaters, and other venues, “business as usual” has largely, but hopefully only temporarily, ground to a halt.
While these shutdowns have not resulted in a wave of new chapter 11 filings (yet), as many lenders and their borrowers patiently take advantage of the relief that the CARES Act and similar legislation has implemented, these unforeseen closures have had predictable yet damaging effects on the ability of pending pre-COVID-19 retail and restaurant debtors already in bankruptcy to reorganize, sell, or liquidate through the chapter 11 process. Store closures have naturally prevented debtors from conducting liquidation sales, and market uncertainty and volatility has complicated, and even paralyzed, preformed restructuring plans.
With important chapter 11 deadlines looming which could spell doom for their bankruptcy cases, several current chapter 11 debtors have sought an unprecedented solution–a temporary suspension of their bankruptcy cases. In asking Bankruptcy courts to put these cases on ice, debtors are asking courts to rely heavily upon general equitable powers captured in Bankruptcy Code section 105–a catch-all section which bankruptcy judges have been extremely reluctant to employ–and overrule the robust and strenuous objections of certain creditors fearing further financial harm to their interests as a result. In these iced cases, those debtors successfully persuaded bankruptcy judges to take extraordinary steps to effectively “freeze” these proceedings in place.
Bankruptcy Cases Currently on Ice
In Modell’s Sporting Goods, Inc., which is pending in the Bankruptcy court for the District of New Jersey, state-mandated store closures scuttled the debtors’ plans to conduct immediate going out of business sales. In response, the debtors froze operations and asked the Bankruptcy court to suspend the case (under the aforementioned section 105 and the seemingly inapposite abstention provisions found in section 305) until sales can resume. Further, despite the unambiguous deadline for the payment of post-petition rent to landlords under section 365(d)(3), the court entered a “suspension order” allowing the debtors to defer all lease-related expenses including rent and utilities. While the suspension order is in effect only through April 30, 2020, this date seems likely to be extended as stores seem unlikely to reopen in the meantime.
Likewise, in Pier 1 Imports, Inc., which is pending in the Bankruptcy court for the Eastern District of Virginia, shelter-in-place orders have necessitated temporary store closures, thwarting Pier 1’s plans to sell the business as a going-concern. Pier 1 convinced the court to impose a “Limited Operation Period” to enable it to stave off liquidation, similar to Modell’s suspension, which allows Pier 1 to defer payment of post-petition rent and other expenses to landlords without requiring any concessions from the debtors in return.
CraftWorks Parent, LLC, currently a debtor in the Bankruptcy court for the District of Delaware, is the owner and franchisor of restaurant brands including Logan’s Roadhouse, Old Chicago Pizza & Taproom, and Rock Bottom Restaurant. Craftworks and its affiliate debtors planned to reorganize around a smaller footprint of key locations (much like Pier 1), but mandatory restaurant closures put all of their business on hold. In connection with their debtor-in-possession financing, Craftworks requested and received approval by the court to pay only “critical expenses” (and, of course, defer post-petition rent and other lease-related expenses) for six weeks of bankruptcy “on ice.”
How Far Will the Freeze Extend?
Next week, we will see whether the freeze extends even further. In Forever 21 currently pending in the Bankruptcy court for the District of Delaware, F21–which purchased Forever 21’s assets earlier this year in a bankruptcy sale–has asserted that it needs court relief as the COVID-19 outbreak has prevented it from conducting going-out-of-business sales and liquidating inventory at certain locations.
F21 seeks, among other things, a modification of the February order approving the sale to prevent landlords whose leases are rejected from dispose 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.” Additionally, F21 has asked to have lease rejections made effective even if the debtors are unable to remove inventory and allow F21 to conduct going-out-of-business sales and store closings “for a period of time commencing when the buyer has re-gained the ability to open and operate such stores and hold such sales pursuant to a safe and reasonable process generally consistent with the process set forth in the sale order.”
Expectedly, landlords have objected to F21’s motion, arguing that the suspension of rent and preventing repossessions would not only violate the Bankruptcy Code and general property law principles, but such “draconian remedies” would also be inequitable because landlords would bear all of the risk and costs. One landlord wrote “[F21] is attempting to create, out of thin air, and to graft into the sale order, a force majeure escape clause provision so that the buyer can realize the optimal solution to its problems in the face of the Covid-19 pandemic.” The landlords asserted that “this is a situation and time in our country where parties should be working together to find reasonable solutions to the challenges that we are all facing.”
Will There Be More Freezes, or a Thaw?
There is no question that these suspensions have changed the bankruptcy landscape with clear patterns beginning to emerge. For debtors facing continued store closures, they have been given a “stay of execution” of a sort by bankruptcy courts willing to employ equitable principles to stretch the Bankruptcy Code to bridge over these unprecedented and complicated circumstances to help debtors achieve chapter 11 objectives that they believe are in the “best interests of creditors.”
On the other hand, landlords and other post-petition creditors argue that the courts, at the debtor’s request, haven’t just bent the rules, they have broken them, and relegated the landlords and other affected creditors to involuntary, unsecured, interest-free lenders during these cases, while debtors are permitted the continued use and occupancy of leased premises rent-free. This has broad ranging implications on the ability for landlords to make mortgage payments which can bubble up to cause new distressed situations for that landlord’s creditors.
Desperate times certainly call for desperate measures. But how long will these freezes last? Will they quickly thaw once retail stores, restaurants, and other non-essential businesses reopen? Will suspensions remain in place for undetermined periods to give debtors a chance to gradually “normalize”? In the face of these challenges and more yet to come, will bankruptcy courts more readily wield (and possibly extend) their equitable powers in favor of debtors and majorities of creditors at the expense of the few, even if doing so forces them to overlook some rules once thought to be sacrosanct?
Landlords and other potentially-affected creditors should seek sound counsel to navigate these lurking icebergs and avoid a Titanic result.
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