Nobody would deny that some companies have struggled to pay rent or invoices on time due to COVID-19. In many such cases, landlords and suppliers of goods or services have accommodated these struggling companies by explicitly or implicitly agreeing to postpone or defer payments in the hope that their customers/tenants would recover after the pandemic is resolved.
By accepting postponed or deferred payments, though, landlords and suppliers of goods and services risk liability for a preference if the customer files bankruptcy. Under 11 U.S.C. § 547, a bankruptcy trustee may claw back any payments made by a debtor if five elements are satisfied, namely that the payment was: (1) to or for the benefit of a creditor, (2) based on an antecedent debt, (3) made while the debtor was insolvent, (4) made within the 90 days before the bankruptcy petition was filed — or within one year if the creditor was an insider, and (5) provided the creditor with more than the creditor would have received in a hypothetical chapter 7 case. The most common defenses, such as the payment(s) being deemed “ordinary course of business,” would likely not apply to an agreement to postpone or defer payments. Under pre-existing law, the available defenses might be limited to “new value” for goods or services provided to the debtor after the payment was received.
The Consolidated Appropriations Act of 2021, which was signed into law on Dec. 27, 2020, creates a new preference defense for some landlords and vendors who enter into agreements with tenants or customers. Specifically, the amendment provides that a trustee may not avoid, or “claw back,” “a covered payment of rental arrearages” or “a covered payment of supplier arrearages.” These two terms are defined to mean payments of arrearages under an “agreement or arrangement” to postpone or defer payments due under a lease for nonresidential property or an executory contract for services or goods if certain conditions are met:
- The “agreement or arrangement” must have been made or entered into on or after March 13, 2020.
- The payments must not exceed the amounts due under the lease or executory contract.
- The “agreement or arrangement” may not include fees, penalties, or interest greater than the sum of fees, penalties, or interest provided for in the original lease or executory contract or the amounts that the debtor would owe if the arrearages had been paid on time and in full before March 13, 2020.
Although this amendment will sunset on Dec. 27, 2022, it will continue to apply in any bankruptcy case that is commenced before the sunset date.
Like any legislation, this amendment creates questions such as:
- What qualifies as an “agreement or arrangement”? Must it be in writing? Could a course of conduct establish an “arrangement” to postpone or defer payments if the facts establish a pattern of the debtor sending and the landlord or vendor accepting payments?
- Will a landlord or supplier lose this protection if the customer defaults under the “agreement or arrangement”? Should the “agreement or arrangement” be formally amended if the customer defaults?
- Can a new “agreement or arrangement” protect payments retroactively? In other words, is it possible to draft an “agreement or arrangement” that protects payments that were received before the agreement is executed?
- Does an agreement that was entered into before March 13, 2020, prevent the parties from entering into a new agreement? Would a new agreement after March 13, 2020, be possible only if there was a material breach in a pre-March 13, 2020 agreement?
For leases and executory contracts that involve large monthly payments, the best practice may be to avoid these and any other questions to the extent possible by proactively entering into formal forbearance agreements that are designed specifically with the requirements of this new defense in mind.
If you have questions about these bankruptcy preferences, contact a member of our Bankruptcy and Restructuring group.
Please visit our COVID-19 Toolkit for all of Taft’s updates on the coronavirus.