Landlords Face Altering Bankruptcy Landscape

Despite the harm COVID-19 unleashed on the economy, trillion-dollar relief efforts like the Paycheck Protection Program, direct stimulus payments and more have largely kept bankruptcies at bay. According to data provider Epiq AACER, overall U.S. bankruptcy filings hit their lowest point since 1986, with the biggest dip seen in individual filings.

However, the same data show 2020 Chapter 11 business bankruptcies jumped 29 percent compared to 2019. On top of that, retail vacancy rates, which stood near 4.5 percent before the pandemic, could hit 6.2 percent by December, according to analytics company CoStar.

These dynamics, along with rent collection being down for multitenant landlords, are producing negative economic results. As evidence, note how sagging apartment rents have forced 12.3 percent more total apartment debt into banks’ highest-risk categories, according to real estate data firm Trepp.

While landlord concessions, eviction moratoriums and relief programs keep some tenants in place, such solutions will not last forever. Additionally, several industries (like restaurants) are caught between government restrictions limiting revenue and the unending cadence of expenses coming due.

The end result is often insolvency and bankruptcy court. But COVID-19 and the new Consolidated Appropriations Act (CAA) have changed bankruptcy, and landlords need to understand these adjustments, because they could have significant impacts for years.

 More Time, Potential Uncertainty

Under the CAA, corporate bankruptcy timelines have lengthened for debtors with $7.5 million or less of debt filing under Subchapter V. The first is the time to perform under the lease (pay rent when due), which traditionally has been 60 days. The CAA stretches the deadline to 120 days, provided the tenant can prove financial hardship due to COVID-19. This means landlords could be unsure of tenants’ intentions for up to four months.

Additionally, the CAA extends a nonresidential tenant’s time to accept or reject an unexpired lease (essentially the final say in how a bankruptcy will proceed) from 120 days to 210 days. Traditional rules allowed for additional 90-day extensions, and the CAA does too. So, the total time to accept or reject a lease could potentially stretch to 300 days. Oddly, if the lease hasn’t been terminated, there could be time where the tenant performs under the lease, but no decision has been made on whether to accept or reject the unexpired lease.

When these timelines are factored alongside eviction moratoriums, it’s clear landlords may have to withstand many months of uncertainty. While we don’t know how long the moratoriums will last, both CAA bankruptcy deadline extensions are set to end on December 27, 2022.

Clear Language Critical

To be sure, keeping tenants out of bankruptcy helps maintain rental revenues. That’s why many landlords continue working with tenants to keep leases intact as much as possible. It is the preferred course in terms of cash flow. But it introduces risk.
To protect themselves, landlords with tenants who have missed rent or sought deferrals must clearly structure how rent should be repaid. One way is to make the balance a loan, which if secured, would take precedence over an unsecured claim in a bankruptcy proceeding.

But as we know, despite best efforts, bankruptcy can happen. Consider again the cases of troubled restaurants. Even if rent concessions and relaxed use provisions were in place, these businesses were effectively shut down by the state and couldn’t generate enough revenue. Otherwise, they would pay.

When a lease situation deteriorates to the point of no return, landlords look to recoup as much lost revenue as possible. This is when lease language becomes critical and ambiguous wording proves troublesome.

As such, landlords should drill down on default and termination provisions, paying attention to any timelines that must be followed. There may be ways to use these conditions to leverage payment before going to court. Similarly, understand force majeure clauses, particularly any exposure related to “act of God” provisions, because many businesses will likely use them. A restaurant almost certainly would, and in the age of COVID-19, that argument could garner favor.

In the end, landlords with tenants facing bankruptcy need to ensure lease language is airtight. If not, the lease language could be used against them.

Future Focus

COVID-19, the CAA and perhaps other forces will continue to shape bankruptcy. It can be tricky for landlords navigating these uncertain waters, especially since every situation brings its own nuances and complexities.

This is where Rehmann can help.

Our experts remain focused on the CAA and can bring clarity when it’s needed most (see our webinar on the CAA at the Rehmann website). For assistance on the CAA or any other related issues, please call me at 248.614.6454 or send an email to carol.wright@rehmann.com.

Published in COVID-19

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