The Consolidated Appropriations Act of 2021 (the “Act”) was signed into law on December 27, 2020, to address the economic impact of the COVID-19 pandemic. For any business which has received a demand letter seeking a “clawback” after one of its customers filed bankruptcy, one particular amendment stands out. The Act amended Section 547 of the Bankruptcy Code to provide suppliers and landlords with an additional potential challenge to actions brought to “clawback” payments made by a debtor in the 90 days preceding bankruptcy. Under the Act, landlords and suppliers can now accept irregular and sporadic payments in exchange for extending credit to the debtor (in the form of goods, services, or leased property) without those payments being deemed a “preference” under the Bankruptcy Code, provided landlords and suppliers do not charge a premium for agreeing to do so.
Section 547 of the bankruptcy code explained
Generally speaking, 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 in the 90 days preceding a bankruptcy case, unless the creditor can establish one of the statutory defenses, including: (1) the payment was made at the same time as the creditor provided goods or services to the debtor (i.e., a contemporaneous exchange); (2) the payment was made in the ordinary course of business (i.e., in the same manner as payments were made before the debtor experienced financial distress) or according to ordinary business terms; or (3) the creditor provided additional goods and services to the debtor on credit after receiving the payment.
The Act added a new subsection 547(j) to the Bankruptcy Code, generally providing 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 defer or 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.
This new provision, which sunsets on December 27, 2022, is subject to certain limitations, including:
- 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.
What is the purpose of the new bankruptcy section 547(j)?
The purpose of new Section 547(j) is to ensure that landlords and suppliers are not penalized for accepting deferred payments (out of the ordinary course) under arrangements they have entered into with tenants or customers affected by the pandemic. Landlords and suppliers are incentivized to explore financial accommodations with their distressed tenants and customers going forward, instead of exercising default and termination rights. However, the statute does not protect certain types of creditors – such as lenders – even though an agreement by any creditor to accept a deferred payment would, presumably, benefit a distressed business just as much as a supplier’s or landlord’s agreement to do so.
Interpreting the new bankruptcy code
The Act’s language contains ambiguity and leaves plenty of room for interpretation. For example, a payment to a supplier must be made pursuant to an “executory contract” but it is unclear whether the contract needs still be “executory” on the petition date. It is also likely the courts will need to resolve what constitutes a deferral “agreement” or “arrangement” for purposes of the statute, and whether such agreement or arrangement qualifies for protection if deferring or postponing the payment of arrearages is part of a larger agreement to restructure the parties’ business relationship involving various forms of consideration. In the meantime, landlords and suppliers who have deferred payments during the pandemic should ensure that they document these deferrals – and avoid charging interest or penalties prohibited by statute – in order to take advantage of Section 547(j) should their tenant or customer file bankruptcy.
How MBM-Law can help you deal with distressed leases or break a lease legally
There are many possible options available for dealing with distressed leases and customers. Landlords and suppliers should thoroughly evaluate their particular circumstances with the MBM Business Law Team to decide the best overall approach for each particular situation. Please contact MBM-Law’s business law team to discuss your options further.