Bankruptcy Code section 365(d)(3) amended to bifurcate rent holiday standards, raises more questions than it answers.
Congress gives Subchapter V debtors double rent holiday based on COVID, but possibly takes away existing rent holidays based on “cause”.
Caselaw permitting traditional chapter 11 debtor to avoid rent may have been altered, considering Subchapter V debtors now are excused from paying much, if any, rent.

This is the tenth in a series of alerts on insolvency topics affecting real estate. In this alert, we discuss recent changes to section 365(d)(3) of the Bankruptcy Code under the Consolidated Appropriations Act, 2021, signed into law on December 27, 2020.

Subchapter V Small Business Reorganizations
The Small Business Reorganization Act (SBRA) went into effect on February 19, 2020. SBRA added “Subchapter V” to the Bankruptcy Code, which affords “small business” debtors the option of pursuing chapter 11 restructuring under either the substantive and procedural laws and rules of (x) “traditional” chapter 11 or (y) Subchapter V. A debtor is eligible for Subchapter V if it owes less than $7.5 million in non-contingent, liquidated secured and unsecured debts. Our alert on Subchapter V, and the potential benefits it may provide for small business debtors, is available at CARES Act Expands Eligibility Under the Small Business Reorganization Act: What Distressed Small Businesses and Their Creditors Should Know.

CCA Amendments to Section 365(d)(3)
The Consolidated Appropriations Act, 2021 (CAA), which became law on December 27, 2020, made significant changes to the Bankruptcy Code, especially section 365(d)(3). There is no legislative history to explain the genesis of these changes, except a press release by a U.S. Senator from North Carolina, Thom Tillis. Based upon our inquiries, leading national bankruptcy organizations such as the National Bankruptcy Conference (NBC) and the American Bankruptcy Institute (ABI) were not consulted on these changes. Further, midway through January 2021, it appears many bankruptcy professionals throughout the country remain unaware of the changes made to section 365(d)(3). Other than Senator Tillis’ press release, the record is devoid of any information on the legislative drafting and policy considerations. Thus, many are trying to assess the implications of these changes, which will play themselves out in the bankruptcy courts.

Bifurcated Standards Raise New Questions and Offer an Answer to an Old Question
CCA changes section 365(d)(3)’s rules regarding a debtor tenant’s obligation to timely perform commercial lease obligations after its bankruptcy filing. While it left unaltered the “rent holiday” language permitting a court to extend for up to 60 days, “for cause,” those obligations arising in the first 60 days of a traditional chapter 11 case (now section 365(d)(3)(A)), it adds a new provision (section 365(d)(3)(B)), which applies only “in a case under subchapter V of chapter 11.”

New subsection (3)(B) allows for both an initial and subsequent 60-day holiday, giving tenant debtors 120 days of relief, where the debtor may be temporarily excused from honoring post-petition obligations (including rent payments). This is a significant change, especially given the speed at which Subchapter V cases usually progress (e.g., the debtor must file a Subchapter V plan in 90 days).

Subsection (3)(B) also introduces and applies a new standard for the debtor to satisfy to obtain its rent holidays. In contrast to subsection (3)(A)’s “for cause” standard (enacted in 1984 and thus not pandemic based), the small business debtor can only obtain an additional 60 days of rent relief if it “is experiencing or has experienced a material financial hardship due, directly or indirectly, to the coronavirus disease 2019 (COVID-19) pandemic.”

The bifurcation and addition of subsection 3(B) raises at least one important question, namely whether small business debtors who elect to proceed under Subchapter V are ineligible for relief under subsection (3)(A). While not obvious during the middle of the pandemic, a small business debtor that cannot satisfy subsection (3)(B)’s pandemic-based standard (whether now or during the two-year horizon for these provisions), may be better off proceeding under the non-pandemic-based “for cause” standard in (3)(A). A small business debtor requiring a holiday that is not pandemic based, however, will be left without a remedy if it cannot proceed under subsection (3)(A). This would seem to be both an unintended consequence of the drafting, and anomalous given that before CCA was enacted (and again after it expires in two years), the very same debtor was and will be eligible to seek “for cause” relief under (3)(A).

While these changes to subsection 365(d)(3) raise new questions, they appear to legislate an answer to an old one; namely, whether chapter 11 debtors not proceeding under Subchapter V are eligible for rent holidays greater than the initial 60 days of the case. Chapter 11 debtor tenants throughout the country intimated in motion papers that they possessed the right, as a matter of bankruptcy law, to obtain rent holidays longer than the first 60 days of the case. A recent major decision in In re CEC Entertainment, 2020 WL 7356380, (Bankr. S.D. Tex. 2020), is the first to hold that no such rights exist. We discuss this case in our eighth installment of this series. Given the express exclusion of non-Subchapter V debtors from subsection (3)(B), new subparagraph (B) appears to restate Congress’ intent that courts may not extend post-petition obligations beyond the first 60 days of the bankruptcy case in non-Subchapter V cases.

Rent Deferral Codified for Subchapter V Debtors, but not Traditional Chapter 11 Debtors
Unfortunately, the legal questions raised by the new provisions of section 365 are not limited to whether a small business debtor can obtain “for cause” relief under 3(A). CCA added new subparagraph (C) to subsection 365(d)(3), which states:

(C) An obligation described in subparagraph (A) for which an extension is granted under subparagraph (B) shall be treated as an administrative expense described in section 507(a)(2) for the purpose of section 1191(e).

Subparagraph (C) introduces a new principle to subsection 365(d)(3); namely, despite subsection 365(d)(3)(A)’s mandate that debtor tenants timely satisfy their rent and other obligations arising after the bankruptcy filing, at least Subchapter V debtors need not do so, and obligations that accrue during the rent holidays will be treated as administrative priority claims. This is potentially a major legal development with implications that will likely be the subject of litigation.

For the uninitiated, chapter 11 debtor tenants failing or refusing to pay rent on a current basis during the case is not a new development; it has been happening for decades. While the facts and circumstances matter, a substantial body of bankruptcy common law exists to support the proposition that despite a debtor’s statutory obligation to pay rent, its refusal or failure to do so often does not result in an order to pay. Instead, many courts award the landlord an administrative claim (with priority over pre-bankruptcy general unsecured claims), on the theory that the claim will eventually be paid in full upon plan confirmation (assuming plan is confirmed); a “no harm – no foul” result. Indeed, this was recently illustrated in the case of In re Pier 1 Imports, Inc., No. 20-30805 (KRH) (Bankr. E.D. Va. March 31, 2020) (Dkt. No. 438).

On one hand, therefore, Congress’ addition of subparagraph (C) to subsection 365(d)(3) codified existing caselaw. However, “(C)” applies only to unsatisfied obligations of Subchapter V debtors arising from extensions “granted under subparagraph (B),” and not unpaid obligations of non-Subchapter V debtors. Accordingly, it is fair to ask whether non-Subchapter V debtors can continue to roll up their unpaid obligations, including rent, and defer paying until a plan is confirmed rather than immediately. Congress is presumed to have known of pre-existing law allowing such deferrals, and yet intentionally excluded traditional chapter 11 debtors from subparagraph (C). See e.g., Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612, 1624 (2018) (Congress is presumed to know about pre-existing law when it enacts legislation.)

If this exclusion reflects Congress’ clear intent, then courts may possibly revisit whether unpaid obligations in non-subchapter V cases can continue to be deferred until confirmation or whether landlords are entitled to receive payments earlier. In any event, the Bankruptcy Code, pre and post CCA, does not provide the answer. Consequently, a landlord is likely to argue that CCA is a reversal of caselaw (in non-Subchapter V chapter 11 cases), and that payment obligations of debtors cannot be converted to administrative claims to be paid at confirmation. Debtors will argue the opposite.

Apart from the doubt now potentially introduced to non-Subchapter V cases, subparagraph (C)’s codification of a debtor’s right to convert present payment obligations into administrative claims that can be paid over the course of plan performance (rather than at plan confirmation, as in traditional chapter 11) raises important legal questions to be resolved in Subchapter V cases.

First, courts may have to determine whether subsection 365(b)(1)(A)’s obligation to cure, as a legal condition to assumption, survived CCA’s amendments. A small business debtor tenant may now argue that new subparagraph (C) expresses Congress’ intent that rather than cure any post-petition payment defaults, the debtor is entitled to make those payments accruing during the case over the term of a Subchapter V plan, and nevertheless assume the subject lease.

Second, courts may have to address (even more so than previously under SBRA) the priority of plan payments between holders of unpaid administrative claims and the lower ranking claims of general unsecured creditors. To be clear, this is (or should be) an issue unique in cases where a non-consensual Subchapter V plan is proposed, because in all other chapter 11 cases, holders of administrative claims possess the legal right to be paid in full upon plan confirmation under section 1129(a)(9)(A). Holders of administrative claims may try to hold up confirmation of a non-consensual Subchapter V plan if it does not provide for payment of their claims in full before the small-business reorganized debtor can make any payments to its general unsecured claims. A consequence of CCA, intended or not, will be shifting more of the burden and costs to process a Subchapter V case to unsecured creditors.

CCA’s amendments to section 365(d)(3) are a legislative mystery. No traditional legislative history exists; no official policy statements exist; and there is no public record as to how the drafting occurred. We do know that despite the importance of the changes, experts from some of the nation’s leading bankruptcy organizations were not consulted. Perhaps as a consequence, while the amendments were apparently designed to provide relief for some small business debtors and answer at least one previously unresolved legal question, they raise new questions for parties to litigate in the federal courts.

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