New Bankruptcy Code Section Protects Commercial Landlords and Contract Vendors from Avoidance Actions for Pandemic-Related Deferred Payments of Tenants and Customers
On December 27, 2020, the Consolidated Appropriations Act of 2021 (the Act) was signed into law. The expansive Act includes several amendments to the Bankruptcy Code, including a notable amendment to section 547 of the Bankruptcy Code. Newly added subsection 547(j) allows landlords and contract vendors to enter into agreements to postpone payments of past due amounts without concern that the late payments will be clawed back as preferences under the Bankruptcy Code.
A Background on Preferences
A core tenet of bankruptcy law is the equal treatment of similarly situated creditors in the distribution of estate property. In furtherance of this goal, section 547 of the Bankruptcy Code enables a bankruptcy trustee (or debtor in possession) to claw back certain payments made by a debtor to its creditors on account of an antecedent debt (such as a past due invoice) within 90 days before the filing of a petition, unless the creditor can establish one of several statutory defenses. If payments are clawed back as preferences, the funds are shared with other creditors. The recipient of the preference is left with an unsecured claim, which generally results in the creditor recouping only a small amount of what it was originally owed.
As written, section 547 provides landlords and vendors with little incentive to negotiate deferred payments with distressed commercial lessees or counterparties. Indeed, a landlord or vendor may reasonably conclude that there is little utility in negotiating and accepting deferred payments when the deferred payment can simply be clawed back in the event of a bankruptcy filing. In those circumstances, a landlord or vendor may opt to declare a default or exercise termination rights and pursue state law remedies. New subsection 547(j) seeks to alter the playing field in favor of exploring financial accommodations with distressed counterparties. But, enacted as a response to the COVID-19 pandemic, the subsection applies only for a limited time.
New Subsection 547(j) of the Bankruptcy Code
The Act eliminates the risk of claw back for landlords and vendors who have entered into forbearance arrangements with distressed counterparties during the pandemic on or after March 13, 2020. New subsection 547(j) to the Bankruptcy Code establishes that a trustee (or debtor-in-possession) may not avoid and recover as a preferential transfer:
- A payment of arrearages under a commercial real property lease made “in connection with” an agreement or arrangement between the debtor and its landlord entered into on or after March 13, 2020 to postpone payment; or
- A payment of past due amounts made to a supplier of goods and services “in connection with” an agreement or arrangement between the debtor and the supplier entered into on or after March 13, 2020.
Limitations on the exceptions include:
- The payment cannot exceed the amount that was otherwise due under the lease with the landlord or executory contract with the supplier before March 13, 2020; and
- The payment cannot include fees, penalties, or interest for deferred payments originally due prior to March 13, 2020.
Significantly, subsection 547(j) is scheduled to sunset on December 27, 2022. It will apply to bankruptcy cases filed on or before that date, but not to cases filed after that date.
New subsection 547(j) ensures that landlords and vendors will not be penalized for accepting deferred payments under agreements made with businesses affected by the pandemic. The Act provides landlords and vendors with an incentive to explore reasonable financial accommodations with an eye towards keeping tenants and customers out of bankruptcy. The Act benefits landlords and vendors by ensuring recovery in the near-term, while also avoiding a claw back if the tenant or customer is ultimately unable to avoid bankruptcy. The Act should also provide distressed tenants and customers with the runway to improve their financial standing, while protecting important commercial relationships with their landlords and vendors.
Subsection 547(j) does have limited application. It applies only to landlords of commercial real property and suppliers of good and services under existing contracts. This exception from the avoidance power under 547(b) does not apply to lenders, for instance, although such lenders are often secured and may have other defenses to preference recoveries under the existing statute.
To capitalize on the advantages of 547(j), landlords and vendors should ensure that they are appropriately documenting deferred payments made during the pandemic and should avoid charging interest or penalties prohibited by the statute.