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Amendments to the Bankruptcy Code Affect Business Bankruptcies
Lending & Restructuring Alert
May 2005
Authors: Paul A. Rubin

Amendments to the Bankruptcy Code Affect Business Bankruptcies 

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "Act").  While the Act's dramatic effects on individual consumers have been widely publicized, the Act also contains several changes that will have important ramifications for business bankruptcies.  These changes will affect virtually all participants in the bankruptcy arena, including landlords, unsecured trade creditors, secured creditors, and utilities.  They will alter pre-bankruptcy planning for prospective debtors, bankruptcy risk analyses of creditors, and Chapter 11 negotiation, litigation tactic and strategy.  Most of these amendments only take effect for cases filed on or after October 17, 2005.  This is the first in a series of Bankruptcy Alerts explaining the Act's implications for commercial bankruptcies.

Issue 1: Implications For Commercial Landlords

New Limit on Debtor's Time to Assume or Reject a Non-Residential Lease

Currently, the Bankruptcy Code ('the Code") allows a debtor at least 60 days after the filing of its voluntary case to assume or reject its commercial leases, and it permits the bankruptcy court to grant a debtor additional extensions of unlimited duration "for cause."  Landlords grew frustrated as denials of extension requests became very rare, despite Congress' 1984 amendments to the Code that were designed to curtail such extensions.  Bankruptcy courts often granted multiple and lengthy extensions, especially in cases of large retail debtors, in which they sometimes pushed out the deadline for several years.  the new law provides that a debtor or trustee will have an initial 120-day period (or until a plan confirmation order is entered, if earlier) in which to decide whether to assume or reject its leases.  The court may thereafter grant only one 90-day extension over the landlord's objection.  Any additional extensions may only be granted upon the prior written consent o the landlord.

Analysis: This change represents a significant victory for landlords.  They will now have certainty as to the date which their leases will be assumed or rejected.  It significantly limits judicial discretion in granting extensions, and strengthens the landlord's bargaining position regarding assumption and assignment.  But this change will likely force both sides to negotiate.  Debtors may find that they must compromise or else make the assumption/rejection decision without having the benefit of operating during the holiday sales season or other time of year when they expect best performance.  Similarly, landlords may feel compelled to consent to further extensions lest debtors vacate retail space during prime sales seasons.  Landlords may also find debtors willing to abandon marginally profitable locations sooner than expected in order to avoid the consequences of imprudent assumption.

A New Cap on Damages Stemming From Rejection of an Assumed Lease

Under current law, if a lease is assumed by a debtor, the landlord would be entitled to an administrative priority claim for all future rent due under the lease, even if the lease is subsequently rejected.  The Act limits the landlord's administrative claim for rejection damages to the "monetary obligations" due under the lease for a period of two years from the later of the lease rejection date or date of the actual turnover of the property, without any reduction or set off except for the amounts actually received or to be received from an entity other than the debtor.  Any remaining amount owed for the balance of the lease term will be treated as a general unsecured claim, subject to the existing statutory cap (which is the greater of one year's rent or 15% of the remaining rent reserved under the lease, not to exceed three year's rent).

Analysis: This amendment is designed to soften the blow that debtors might suffer from improvident assumptions made as a result of the new concrete deadline for assumption of rejection.  Based on the language chosen by Congress to describe the landlord's administrative claim for damages form a post-assumption rejection (i.e., "monetary obligations" instead of "rent" due under the lease), it appears that the landlord's administrative claim will include pass-through expenses such as CAM charges, taxes, interest and other related fees, in addition to rent.

Relief for Debtors From Incurable, Non-Monetary Defaults

Some courts have held that debtors are barred from assuming leases if they committed incurable non-monetary defaults, such as store closings that violated so-called "going dark" prohibitions in their leases.  The Act permits debtors to assume leases if it is impossible to cure non-monetary defaults at or after the date of assumption, and leaves the landlord with a claim for monetary damages for pecuniary losses resulting from such defaults.

Analysis: This change will benefit debtors by removing a potential impediment to assumption and assignment.  It is unlikely that a landlord will want to go to the expense of proving in court the monetary loss suffered from a temporary cessation of operations at the leased premises.

Shopping Center Landlords Take Note: Enhancement of Use Restriction Clauses

The Code provides that to assume a lease, the debtor or trustee must provide the landlord with adequate assurance of future performance of the tenant's lease obligations. In the case of a shopping center tenant, the landlord must be adequately assured that the assumption or assignment of the lease is subject to all of its provisions including, but not limited to, radius, location, use, exclusivity and non-disruption of the overall "tenant mix." But some courts have held that another Code provision, which invalidates anti-assignment clauses in leases, overrides the Code's shopping center adequate assurance requirements, including use restrictions. The Act overrules such cases, and clarifies that the specific adequate assurance provisions are superior.

Analysis: Congress' intent here is to preserve a landlord's bargained-for protections regarding property use spelled out in the lease. But landlords should expect debtors seeking to assume and assign leases to try to circumvent use restrictions by arguing that the provision in question effectively prohibits an assignment of the lease. Such contentions will have to be addressed on a case-by-case basis.

Additionally, this amendment, together with the new 210-day deadline for assumption or rejection of a commercial lease, will likely limit the practice whereby debtors' sell "designation rights" to third parties who then have additional time to market and choose the ultimate end-user of the debtors' properties. The amendments can be expected to depress the value of designation rights, since the debtors will have a shorter time frame, in which to assume or reject, and the designation rights purchaser will have to find users who will comply with the leases use clauses.

A Concluding Cautionary Note

Overall, it appears that the Act favors landlords and enhances their negotiating leverage. But one must bear in mind that landlords thought the same when Congress amended the Code in 1984, seemingly in their favor. Debtors' counsel can be expected to look for avenues in which to extract further extensions and additional concessions from landlords notwithstanding the new restrictions placed upon them.

For more information regarding the implications of the revisions to the Bankruptcy Code, please contact Paul Rubin at 212-592-1448 or prubin@herrick.com.

Copyright © 2005 Herrick, Feinstein LLP. The Bankruptcy Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.