INSIGHT: Bankruptcy Amendments Could Help Businesses After Coronavirus

The coronavirus pandemic has a still unfolding and unprecedented global impact on daily lives, businesses, and economies. Most Americans are ordered to stay home. Scores of businesses are unable to operate while other businesses’ customers have no money to spend. Chain reactions await.

For instance, the restaurant or movie theater defaults on rent owed the landlord which then defaults on its mortgage payments. That syndrome triggers defaults of mortgage backed securities. Heightened market volatility pending the unknowable timing of therapies, vaccines, and public willingness to resume normalcy, renders a wave (or tsunami) of bankruptcies fairly inevitable. But ironically, at present, bankruptcy liquidation sales cannot even occur because no one is allowed to attend, except online.

Adapting to the New Normal

Bankruptcy courts have already been adapting to the new abnormal, granting extraordinary motions to ‘mothball’ or partially freeze the case (for example, in the Chapter 11 cases of Modell’s, Pier 1, and Craft Works) to preserve liquidity while lockdowns are in place. While the Bankruptcy Code provides flexibility to address these circumstances, carrying out the traditional public bankruptcy policies of saving the going concern, preserving jobs, and maximizing value, will be hamstrung absent Bankruptcy Code amendments.

Without amendments, first lien creditors will usually be in the driver’s seat deciding between liquidations and business continuations, regardless of what could save jobs and preserve value for other creditors and shareholders.

Changes to the Bankruptcy Code that could save more businesses from the pandemic’s fallout must increase opportunities to rehabilitate the debtor as a going concern and maximize value to benefit more stakeholders. They include repealing several amendments made at the instance of certain powerful interests during the last 15 years. Interestingly, hedge funds adapt to whatever the rules are. They just want clear rules.

The changes that would most promote debtor rehabilitation and value maximization, include the following:

1. Allow Bankruptcy Judges to Further Extend the Debtor’s Exclusive Right to Propose a Chapter 11 Plan Beyond 18 Months

Until 2005, the bankruptcy judge could extend the debtor’s exclusive right to propose a Chapter 11 plan and decide whether and when creditors or shareholders could propose their own plans.

This served two purposes. It allowed the bankruptcy judge to prevent creditors from proposing liquidation plans that might pay off first lien creditors, but terminate the business, lose jobs, and forfeit value that might otherwise extend to other creditors and shareholders.

Second, it helped assure a debtor’s management that creditors would not displace them too easily. In the name of shortening Chapter 11 cases to minimize professional fees so ‘they would not be prosecuted for the benefit of the professionals,’ Congress placed an 18-month limit on the debtor’s exclusivity. That sounds great.

In reality, however, it created an undervaluation opportunity. Generally, to exit Chapter 11 in 18 months, the debtor has to propose a plan in 12 months. That means the debtor would have to be valued on trailing financials that frequently do not reflect improvements made during the Chapter 11 case.

Thus, senior creditors would receive a disproportionate share of an undervalued company, at the expense of other stakeholders. Additionally, contrary to the soapbox pitch about professionals, the financial, business, and legal professionals often add immense value to a debtor’s business, which value does not materialize until after the business operates a second year or until litigation is completed.

2. Allow Bankruptcy Judges to Extend a Debtor’s Time to Assume or Reject Store Leases as Long as Rent Is Timely Paid

Retailers having more than 50 stores, let alone more than 1,000, cannot implement a new business plan and sell the unneeded leases for profits in the 210 days the Bankruptcy Code provides each debtor to assume or reject each lease. Once the debtor assumes a lease, it becomes an administrative expense.

To be sure, landlords rebel at the notion a tenant can procure value from its lease, but let’s face it. The tenant bargained for the premises for the full term of the lease and if market rents climb higher than the tenant’s rent, that differential belongs to the tenant and its stakeholders.

In any event, retailers will largely be unable to reorganize if landlords can grab their leases in 210 days. As long as the debtor-tenant pays its full rent timely, the court should be allowed to extend the time for the tenant to assume, reject, or sell its leases.

3. Provide Developers, Shareholders, and Owners Better Opportunities to Retain Their Businesses

Over time, the rights of a real estate developer or shareholder to retain its project or business have eroded, unless all debt is paid in full. While that sounds equitable, it is often not. If a mortgagee loaned $10 million against a building that declined in value to $7 million, the mortgagee will only recover $7 million if the property is turned over to it.

Accordingly, if the owner manages to raise $7 million and offers to pay it to the mortgagee, why shouldn’t the owner be allowed to keep the building? In the current crisis, many owners will lose their real estate or other business if the law does not allow such a payoff. To date it has been an uphill battle for owners providing ‘new value’ to retain ownership of the reorganized debtor. Therefore, the law should expressly allow it.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Martin Bienenstock is chairman of the Bankruptcy Solutions, Governance, Restructuring and Bankruptcy group at Proskauer Rose LLP. Martin also teaches Corporate Reorganization at Harvard Law School, University of Pennsylvania Law School, and University of Michigan Law School.

Maja Zerjal is a partner in Bankruptcy Solutions, Governance, Restructuring and Bankruptcy group at Proskauer Rose LLP.

The opinions herein are their own, and not opinions of the law firm or any law school.