On March 13, 2020, the president officially declared the COVID-19 pandemic a national emergency. In a matter of weeks, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) as its initial legislative response to combat the economic fallout from the deadly virus. Exactly nine months later, on December 27, 2020, the Consolidated Appropriations Act (CAA), 2021 (H.R. 133) was signed into law.
In addition to funding the federal government and providing a second wave of COVID-19-related relief, the CAA includes several amendments to the U.S. Bankruptcy Code intended to address the economic consequences suffered by individuals, businesses, vendors, and landlords as a result of the pandemic. The majority of these amendments sunset in either one or two years after enactment. While the bulk of amendments apply only to Subchapter V small business debtors and Chapter 12 and 13 debtors, there are several key amendments that also affect the treatment of leases and preferences under all chapters of the Bankruptcy Code.
Most significantly, the CAA adds a provision to Section 364 of the Bankruptcy Code that would resolve the split among courts regarding the ability of debtors in bankruptcy to benefit from the Paycheck Protection Program (PPP). The remaining amendments provide debtors and courts with greater flexibility to deal with the impact of COVID-19 by, among other things, extending the statutory deadline for debtors to assume leases for nonresidential real property.
A critical component of the economic relief provided to businesses under the CARES Act was funding of the PPP, a temporary loan program administered by the Small Business Administration (SBA) under which applicants can obtain unsecured loans to fund payroll, mortgage interest, rent, and utility costs.
Nothing in the CARES Act prohibits a debtor in bankruptcy from applying for or receiving a PPP loan, or otherwise limits the availability of PPP loans based on an applicant’s status as a debtor in bankruptcy. Nevertheless, the PPP loan application form issued by the SBA asks if the applicant is “presently involved in any bankruptcy.” The official form states that if the answer is yes, the loan will not be approved. Weeks after the PPP became effective, the SBA issued its interim final rule stating that debtors in bankruptcy are ineligible for PPP loans because they are more likely to use loan proceeds for noncovered expenses and less likely to be able to repay portions of loans that are not forgiven.
Almost immediately, debtors challenged the SBA’s rule, and courts were split on the issue as to whether PPP loans were available to companies in bankruptcy. The 5th and 11th U.S. Circuit Courts of Appeals—the only two appellate courts to rule on this issue—have sided with the SBA and held that debtors could not obtain PPP loans. See USF Federal Credit Union, et al. v. Gateway Radiology Consultants, P.A., Case No. 20-13462, 2020 WL 7579338 (11th Cir. Dec. 22, 2020); In re Hidalgo Cnty. Emergency Serv. Found., Case No. 20-40368, 2020 WL 3411190 (5th Cir. June 22, 2020).
The CAA amends Bankruptcy Code Section 364 by adding a new subsection, 364(g), that permits Subchapter V small business debtors, Chapter 12 debtors, and self-employed Chapter 13 debtors to obtain PPP loans in bankruptcy. The amendment requires the bankruptcy court to hold a hearing within seven days after filing and service of the debtor’s motion for authority to obtain a PPP loan. If the PPP loan is not forgiven by the SBA, it will be treated as a superpriority administrative expense and may be paid back under the debtor’s plan of reorganization on the favorable terms under which it was originally made.
While the CAA attempts to resolve the PPP loan issue, it does not overrule the SBA. The amendment to Section 364 provides that PPP loans will be available to debtors only if the SBA administrator sends a letter to the director of the Executive Office for the U.S. Trustee Program agreeing to PPP loans in bankruptcy. The SBA has not provided its written blessing. Rather, in mid-January 2021, the SBA issued an interim final rule expressly stating that debtors in bankruptcy do not qualify for PPP loans.
Nothing in the CAA, however, prevents the SBA from changing its position simply by issuing a letter to the Office of the U.S. Trustee. If approved in the future, PPP loans will be available only in cases filed after the date that the SBA sends such a letter and prior to December 27, 2022, when the amendment expires.
Under Section 547 of the Bankruptcy Code, payments to a creditor within 90 days of a bankruptcy filing can be recovered or clawed back by the bankruptcy estate as a preferential transfer if made on account of a preexisting debt. To account for the substantial concessions made by vendors and landlords to help companies survive during the pandemic, the CAA amends Section 547 by adding a new subsection, 547(j), to protect certain deferred payment arrangements from being targeted as alleged preferential transfers. The preference exemption for covered payments to landlords and vendors in Section 547(j) applies to cases under all chapters of the Bankruptcy Code commenced before December 27, 2022.
To qualify for the exemption, the payment must fall within the definition of a “covered payment of rental arrearages” or a “covered payment of supplier arrearages.” This requires that (a) the debtor and the counterparty have (i) entered into a lease or executory contract before the petition date and (ii) subsequently entered into an “agreement or arrangement” in connection with the lease or contract after March 13, 2020, and (b) such “agreement or arrangement” must have deferred or postponed payments otherwise due under the lease or contract. The preference exemption does not apply to the payment of fees, penalties, or interest imposed in the post-March 13, 2020, “agreement or arrangement.”
While the text of this amendment leaves open the question of what qualifies as an “agreement or arrangement,” use of the term “arrangement” could indicate Congress intended for the scope of the term to be broadly interpreted. Notably, the amendment also does not address payments to insiders during the preference period.
While the amendment to Section 547 protects certain prepetition payments to landlords, two amendments to Section 365(d) of the Bankruptcy Code provide debtors with additional breathing room during the postpetition period. Under Section 365(d)(4), a debtor has 120 days from the bankruptcy filing to decide whether to assume a commercial real estate lease. The CAA amends Section 365(d)(4) to give the debtor 210 days after the order for relief to assume such a lease. This change applies to cases under all chapters of the Bankruptcy Code.
As under prior law, the court may extend the initial 210-day period for up to an additional 90 days, for a total period of 300 days. On December 27, 2022, the time to assume or reject an unexpired nonresidential real property lease will revert to 120 days.
Notably, the amendment does not address the treatment of unexpired leases that, on the December 27, 2022, sunset date, have not been assumed or rejected in the initial 210-day period, but where more than 120 days have passed since entry of the order for relief. To avoid this issue, debtors may consider seeking an extension under Section 365(d)(4)(B) prior to December 27, 2022. For Subchapter V small business debtors, the amendment will continue to apply to those cases commenced before December 27, 2022.
The second amendment to Section 364(d) applies solely to Subchapter V small business debtors. Section 365(d)(3) of the Bankruptcy Code requires Chapter 11 debtors to continue paying rent and performing all other obligations under a commercial real estate lease from and after the bankruptcy filing date. If cause exists, the court may extend the time of performance under such lease for up to 60 days. The CAA amends Section 365(d)(3) by adding a new subsection, 365(d)(3)(B), that gives the court authority to extend the period an additional 60 days for a Subchapter V small business debtor to perform under a commercial real estate lease “if the debtor is experiencing or has experienced a material financial hardship due, directly or indirectly, to [COVID-19.]”
This change provides qualified debtors with a total of 120 days to perform under such a lease. Notably, any deferred obligations that are unpaid at confirmation constitute administrative expenses, but the debtor may spread the payments out over time under the confirmed plan. These changes apply only to cases commenced under Subchapter V before December 27, 2022.
The CAA also amends Section 525 of the Bankruptcy Code to expand the scope of protections for debtors against discriminatory treatment during and after bankruptcy. The CAA amends Section 525 by adding a new subsection, 525(d), to provide that no person may be denied relief under three CARES Act provisions solely because the person is or was a debtor in a bankruptcy case. The three CARES Act provisions are: (a) the foreclosure moratorium and right to request forbearance (15 U.S.C. Section 9056), (b) the forbearance of mortgage payments for multifamily properties (15 U.S.C. Section 9057), and (c) the temporary moratorium on eviction filings (15 U.S.C. Section 9058). On December 27, 2021, Section 525(d) of the Bankruptcy Code will be stricken in its entirety.
Lastly, the CAA amends Section 507(d) of the Bankruptcy Code so that a party that pays the U.S. government a customs duty on behalf of an importer is subrogated to the government’s priority status under Section 507(b)(8)(F) for such customs duties. Under previous law, Section 507(d) prevented priority subrogation for customs brokers and forwarders that frequently pay the government for customs duties on behalf of their importer-clients. On December 27, 2021, this amendment will be stricken in its entirety.
The CAA appears to reinforce the appellate court holdings on the availability of PPP loans to debtors, as it provides the SBA with the continuing power to determine debtor eligibility.1 Even without the PPP lifeline, the CAA provides many benefits to small businesses considering bankruptcy under Subchapter V of Chapter 11. The provisions protecting landlords and vendors from the threat of disgorgement where they sensibly entered forbearance agreements to provide financial assistance to struggling businesses are a needed response to the economic reality of this unprecedented pandemic.
1 Although not discussed in this article, the CAA amends the Bankruptcy Code in at least three other respects that are applicable solely to individual debtors, including amendments to (i) Section 1329 authorizing the modification of Chapter 13 plans to address deferred mortgage payment plans arising under the CARES Act for eligible mortgagors; (ii) Section 1328 giving the court discretion to grant a discharge to a Chapter 13 debtor even though the debtor defaulted on not more than three monthly residential mortgage payments due to a COVID-19-related financial hardship; and (iii) Section 366 prohibiting a utility from altering service for an individual debtor who makes timely postpetition payments—even if the individual debtor did not otherwise provide the utility with adequate assurance of payment.