Recent legislation has expanded opportunities for commercial landlords and tenants to negotiate deals to defer certain rent payments during the COVID-19 pandemic with less fear of later losing the arrearage payments as preferences if the tenant files for bankruptcy. These changes, enacted in the Consolidated Appropriations Act, 2021 (CAA), provide a safe harbor that can be used as parties negotiate how to weather current economic uncertainties.
What is a Preference?
Section 547 of the Bankruptcy Code allows bankruptcy trustees and debtors-in-possession to avoid certain transfers made by a debtor within the 90 days before the debtor’s bankruptcy filing. If the transfer is made to an insider, this period is expanded to one year before the bankruptcy filing. These avoidable transfers are commonly known as preferences because the creditor is “preferred”—it receives more than it otherwise would receive in a liquidating bankruptcy case.
Preference payments can be avoided or “clawed back” from the creditor by a bankruptcy trustee or debtor-in-possession for administration in a bankruptcy case. There are, however, some statutory exceptions. For example, certain payments made in the ordinary course of business, made for new value, or made as part of a contemporaneous exchange are expressly exempted from avoidance as preferences.
If a payment does not fall within such a statutory exception, however, the creditor accepting late payments risks later losing the right to keep those payments if the debtor files for bankruptcy. This can complicate, and potentially deter, some arrangements to defer or postpone payments.
New Opportunities, But for a Limited Time Only
As the COVID-19 pandemic has continued, so has the deferral of payments. As part of its multifaceted approach to pandemic relief, the CAA added a new provision to the Bankruptcy Code, subsection 547(j), which exempts certain arrearage payments from being clawed back as preferences.
This new exception applies to arrearage payments made in connection with an arrangement between a debtor tenant and its landlord to defer or postpone rent payments and other periodic charges for nonresidential real property leases. The exception is designed to protect arrangements made in light of the COVID-19 pandemic, as it only applies to arrangements made on or after March 13, 2020.
By exempting these arrearage payments from avoidance as preferences, the CAA has created a safe harbor commercial landlords and tenants can use to guide their negotiations of deferral agreements. Because there are several specific requirements and limitations for this new safe harbor, we recommend consulting with an attorney to review the details of a proposed arrangement before it is finalized to verify that it is appropriately constructed to receive protection under the new safe harbor.
This new safe harbor benefits landlords’ lenders as well. By providing greater certainty landlords will be able to retain arrearage payments made pursuant to properly drafted deferral agreements, subsection 547(j) allows lenders to better evaluate the financial health of landlords and the condition of their loans. This will help lenders in their classification of loans to landlords.
Landlords, tenants, and lenders should keep in mind that this new relief is temporary. Subsection 547(j) is scheduled to sunset on December 27, 2022, unless later extended. The sunset date is important to consider when negotiating deferral agreements, as arrearage payments made on or after this date will no longer receive the same protections, and could be avoided as preferences, and payments near that date could be at risk.
Overall, the addition of this new safe harbor provides commercial landlords and tenants with an opportunity to negotiate deferral arrangements with a better picture of the associated risks and rewards. Though temporary, subsection 547(j) provides some additional certainty as landlords and tenants navigate these extraordinary times.
This article is also posted on Bank Law Monitor, Miller Nash’s financial services blog.