New Year Brings Revisions to the Bankruptcy Code, Fodder for Bankruptcy Court

The new year brings several changes to bankruptcy practice through the enactment of the Consolidated Appropriations Act, 2021 (CAA), which augments the CARES Act by expanding the Paycheck Protection Program (PPP), adding stimulus programs and installing coronavirus relief valves for troubled sectors of the economy.[1] Those relief valves include temporary revisions to the Bankruptcy Code in the areas of debtor-in-possession (DIP) financing, avoidable preferences, nonresidential real property leases, mortgage-servicing, custom duties and more. This article focuses on and highlights areas of uncertainty in two such areas: (1) the potential utilization of PPP loans for DIP financing; and (2) the new preference safe-harbor for certain deferred obligations.

Congress Creates Key to PPP DIP Loans, Hands Key to SBA

The CAA appropriates $284.45 billion to reopen the PPP program and provide a second round of loans to existing borrowers. The Small Business Administration (SBA) previously promulgated regulations disqualifying debtors in bankruptcy from the program. These regulations were challenged in bankruptcy and appellate courts across the country with mixed results that created widespread uncertainty about debtors’ qualification for PPP loans. The CAA resolved that uncertainty by substituting it with a new form of uncertainty. The CAA amends § 364 and other sections of the Bankruptcy Code to allow debtors in possession (and trustees) in chapters 12 and 13 and subchapter V of chapter 11 to obtain PPP funds if they are otherwise eligible — but the amendments will go into effect only if the SBA reverses its position that debtors in possession or trustees can be eligible for PPP loans.[2]

If these amendments to the Bankruptcy Code do take effect, the debtor or trustee may apply to the bankruptcy court for approval of a PPP loan, which would be treated as a super-priority administrative expense under §§ 364(c)(1) and 503(b), unless and until it is forgiven. The amendments to § 364 also provide that a debtor may obtain a PPP loan notwithstanding existing cash collateral or DIP-financing arrangements that would otherwise prohibit subsequent borrowing. Furthermore, the Bankruptcy Code’s relevant plan-confirmation provisions would also be amended to permit confirmation of a plan that pays a PPP loan according to its terms, notwithstanding the super-priority status of PPP loans in bankruptcy. It will be interesting to see whether the SBA changes its position and whether courts will be asked to intervene and interpret the CAA to require that the SBA promptly initiate relief for these struggling debtors.

Congress Creates Preference Safe Harbor, Hands Navigational Compass to Courts

Creditors of troubled companies generally know to be wary of “catch-up” payments and other transfers made outside of the ordinary course of business, as § 547 of the Bankruptcy Code allows such payments to be clawed back as preferences if they are made within 90 days before a debtor’s bankruptcy filing. Yet the pandemic has in many ways turned the notion of “ordinary course of business” on its head, making catch-up payments the rule rather than the exception in debtor/creditor relationships. The CAA attempts to alleviate preference risks in light of widespread business disruption by creating a temporary safe harbor for “covered payment[s] of rental arrearages [and] ... supplier arrearages.”[3] These terms refer to certain arrearage payments, either to a lessor of nonresidential real property or a supplier of goods or services, made by the debtor pursuant to an “agreement or arrangement” entered on or after March 13, 2020, to defer or postpone the payment of amounts due.[4]

The CAA states that a “covered payment” of supplier arrearages may not (1) “exceed the amount due under the executory contract [for goods or services] before March 13, 2020,” or (b) “include fees, penalties, or interest [to be paid under the executory contract] in an amount greater than the amount of fees, penalties, or interest — (I) scheduled to be paid under executory contract ... or (II) that the debtor would owe if the debtor had made every payment due under the executory contract ... on time and in full before March 13, 2020.”[5] There are three key takeaways from this muddled statutory language:

1. The supplier contract underlying the payment deferral agreement must be an “executory contract.”
2. The exempted payment must not exceed the amount that was due before March 13, 2020.
3. The exempted payment cannot include late fees, penalties or default interest for failing to make payments that came due before March 13, 2020.[6]

The intent of this language appears to be aimed at protecting creditors that permitted late payments when widespread business interruptions began on or about March 12, 2020. But the drafting of the language is looser and seems to protect a cumulatively wider swath of payments, so long as (or to the extent that) each such payment is equal to or less than the amount due on March 12. Suppose, for example, the debtor owed $100,000 to a supplier on March 12; the debtor accrued an additional $500,000 in arrearages between April and September 2020; and entered into a forbearance agreement in October 2020. Assuming a Jan. 30, 2021, bankruptcy filing, the debtor could make six payments of $100,000 each over the course of November, December and January — and each such payment would appear to fit within the language of the safe harbor.

The treatment of payments to commercial lessors is addressed with somewhat different language. Whereas covered payments to suppliers are tied explicitly to the amount due before March 13, 2020, covered payments to commercial lessors may “not exceed the amount of rental and other periodic charges agreed to under the lease of non-residential real property ... before March 13, 2020.”[7] The intent of this language appears to limit the lessor’s safe harbor to amounts collected during a preference period only to the extent that those payments are not in excess of the amounts provided for under the lease (such that the lessor could not protect any payment that has been enhanced under the terms of the forbearance agreement); however, there remains a question as to whether the specific language of the statute accomplishes this intent.

For all covered payments, it is clear the creditor must enter the qualifying forbearance agreement or arrangement prior to making the arrearage payments (and, of course, prior to the bankruptcy filing). What is not clear is how courts will construe the many other chronologically complex or ambiguous terms contained in the legislation, including what qualifies as an “arrangement,” a term that principles of statutory construction would suggest encompasses circumstances beyond the execution of a formal forbearance agreement.

Parting Thoughts

Congress has attempted in earnest to provide critical relief valves to both debtors and creditors managing the economic fallout from COVID-19. But, as is often the case with bankruptcy legislation, the accessibility and operability of some of those relief valves create open questions that bankruptcy courts will undoubtedly be asked to answer.