Insolvency Guide for Lenders, Landlords, Lessees, and Others Dealing with the COVID-19 CrisisMarch 18, 2020
The economic havoc unleashed by the COVID-19 crisis in most sectors of the economy will affect businesses and their employees, servicers, customers, and others for the foreseeable future. Among those that are directly and critically affected are banks and other lenders, commercial landlords and tenants, restaurants, and the travel and hospitality industries. All of these areas will see an increase in bankruptcy filings and other insolvency proceedings in the near term. Here is a short guide for some of the issues that will arise in the coming months.
Tenants, especially restaurants, bars, entertainment venues, and retailers, are expected to be among those hit hardest. Landlords should prepare now and explore their options. If a tenant falls into default, the landlord should consider exercising its remedies promptly before the tenant files a bankruptcy petition. Once the tenant files for bankruptcy relief, a lease that has not been terminated under the terms of the contract and applicable law will become part of the debtor’s bankruptcy proceedings, and the provisions governing landlords are complicated and extensive. Consequently, acting quickly before a bankruptcy filing can save a landlord significant cost and time. Once a bankruptcy case is filed, debtor tenants have 120 days, plus a possible 60 day extension, to decide whether they want to continue with a lease or reject it (in a chapter 11 case); in a chapter 7 liquidation, the debtor has 60 days. During these windows of time, the landlord generally has few options and must defer to a debtor’s decision timeframe. At the same time, the bankruptcy code affords landlords protections regarding ongoing rent obligations. Landlords must be vigilant throughout the process and be prepared to assert their rights.
Banks and Other Lenders
All banks and lenders will see the fallout from COVID-19 on some of their borrowers. Whether their borrowers are retailers, manufacturers, travel providers, hotels, or restaurants (and many others that are being affected), lenders need to be prepared for the inevitable interruptions on their customers’ business and corresponding effect on their ability to service their debt. Lenders have two main options: forbearance agreements and loan modifications.
Forbearance Agreement: Under a forbearance agreement, a lender agrees to delay enforcement of its legal rights against a borrower in exchange for some consideration being given to the bank, including a forbearance fee, pledge of additional collateral, retention by the borrower of a restructuring manager, sale of certain collateral to reduce debt, the addition of a guarantor, and waiver of the automatic stay in bankruptcy. Notably, the borrower will remain in default during the term of the forbearance agreement and must comply with the agreement to avoid the lender exercising all of its remedies.
Many other options are available to both lenders and borrowers as part of a forbearance agreement negotiation, and both sides should be considering their options now, before the current crisis limits the range of options.
Loan Modification: A loan modification allows the lender to extend, amend, or modify the existing loan documents between the parties. These are generally used before a borrower is in default but sees problems – such as the commercial interruption being caused by COVID-19 – that will be arising shortly. By being proactive in addressing the expected economic distress to a borrower, a lender may be able to improve its position while providing relief to a good borrower that is suffering some immediate stress.
All creditors and debtors need to be aware of the range of options during these highly uncertain financial times. Restructuring in bankruptcy typically comes to mind first, though other options should be considered. The Bankruptcy Code provides significant protections to debtors, including the automatic stay upon filing against any collection activity against the debtor and its assets, giving the debtor some breathing space to develop a comprehensive reorganization plan for approval by the court and creditors. The Code likewise tries to balance the debtor protections against the rights of creditors, including the right of a creditor to seek relief from the automatic stay and adequate protection of any collateral the creditor may hold. These immediate issues are the mere starting points for debtors and creditors to address in a bankruptcy case.
Bankruptcy, however, should be a last resort after other options have been considered. One alternative is a receivership. Creditors (and debtors) can seek a receiver to be appointed for a debtor or a debtor’s property. Receivership proceedings can be commenced in state or federal court. Missouri has recently adopted a comprehensive commercial receivership act that largely mirrors the process of a chapter 7 bankruptcy case, including a version of the automatic stay. Receiverships often are less costly than a bankruptcy case, and a receiver has great flexibility to manage the debtor or debtor’s property for the benefit of all parties during a case. The court oversees the receivership generally, but the management of the debtor’s business falls primarily to the receiver, who will report to the debtor and creditors regularly. This allows all parties to feel reasonably comfortable, under the circumstances, that their interests are being protected.
Additional alternatives include assignments for the benefit of creditors, through which a debtor’s assets are conveyed to an independent third party (typically a restructuring lawyer or other reorganization professional), who then liquidates the assets for the benefit of all creditors. This out-of-court option is fast and less expensive than bankruptcy and receivership. Also available is the statutory dissolution of a company, according to the governing state laws. Dissolutions allow for the formal termination of the existence of the company after distribution of its assets to appropriate parties.
All parties suffering or affected by COVID-19 should be proactive in considering how they will address this crisis. Tools are available to lessen the inevitable financial pain, and all sides should take steps now to further minimize the fallout.
In response to the coronavirus (COVID-19) pandemic, Lewis Rice has formed a COVID-19 Task Force which brings together subject matter authorities from various practice areas within the Firm who stand ready to assist our clients as they navigate these challenging and evolving issues. We will continue to monitor the myriad legal and other developments that may impact our clients.
If you have legal questions related to COVID-19, please reach out to one of the authors above or another member of the Task Force.