Since the start of the coronavirus pandemic, a large number of commercial tenants have to contend with the challenge of whether local or state regulations permitted their organization to remain open. Unfortunately, this means that many companies have been unable to generate revenue for the past year. 

Given the financial hardships faced by many people and businesses during the pandemic, countless commercial landlords have worked with tenants to avoid eviction. Whether in the form of rent deferral or temporary partial payments, landlords are at risk of facing various hardships if a tenant files for bankruptcy.

To address the vulnerability faced by landlords in such a situation, Congress passed the Consolidated Appropriations Act of 2021, which in part amended the Bankruptcy Code to protect commercial landlords from preference claims. The amendment applies to late payments made as part of agreements entered into on March 13, 2020, or any date afterward. To address a vulnerability faced by landlords, the Act eliminates the ability of trustees to later obtain back payments if a tenant ends up pursuing bankruptcy. This revision to the bankruptcy code has the immediate effect of making it substantially easier for landlords to help distressed tenants avoid permanently closing their businesses because they cannot make commercial rent payments.

Appreciating the Role of Preferences

To ensure fairness, bankruptcy relies on several underlying elements including that similarly situated creditors receive the same treatment during the distribution process. To help achieve this goal, Section 547 permits bankruptcy trustees to “claw back” payments made by a debtor to creditors, provided certain requirements are met. If payments are classified as preferences, funds from these amounts are then distributed to other creditors. The recipient of a preference claim is then left with unsecured claims, which often leads to a creditor recouping only a portion of what was initially owed. 

Section 547 provides landlords with little incentive to address deferred payments with distressed commercial lessees. Landlords often conclude that there is little reason in both negotiating and accepting deferred payments if a bankruptcy filing is involved. 

Understanding How Preference Actions Function

The Bankruptcy Code authorizes trustees to avoid as well as recover “preference” payments made to credits within the 90 days after a bankruptcy filing. This law was created to reduce reports of aggressive collection after a person files for bankruptcy.

Preferences do not include all payments made before bankruptcy. Instead, Section 547 of the Bankruptcy Code states that preference payments must:

• Payments made on previously accrued rather than present debts
• Payments made while a debtor was unsolved or had fewer assets than liabilities
• Payments made within 90 days of filing for bankruptcy
• Payments that allow creditors to receive more from a claim than what would have been received if the payment was not made and the claim was paid as part of a bankruptcy proceeding

Payments that satisfy these elements must be repaid to the trustee. Following the repayment of debts to a trustee, creditors sometimes file unsecured proof of claims. In these situations, the creditor will still receive an amount that is drastically less than what is owed. Creditors who are familiar with the Bankruptcy Code often avoid doing business with distressed companies to reduce the risk of having to return payments to a trustee. The new protection, however, helps to alleviate some of the common complaints brought up by creditors.

What the New Preference Protection Code Means

Among its various changes, the Consolidated Appropriations Act adds section  547(j) to the Bankruptcy Code in the hopes of encouraging payments to landlords for the rest of the pandemic. The Code establishes various protections to the landlords of non-residential property who received deferred payments following March 13, 2020. The new subsection will remain in effect for two years until it expires on December 27, 2022. 

Preference payments, however, do not exist without limitations. One, limitations cannot exceed amounts that are otherwise due under a lease with a landlord before March 13, 2020. The payment cannot include fees, interest, or penalties for deferred payments that were initially due before March 13, 2020. 

The Impact of the Revision to 547(j)

Subsection 547(j) prevents landlords and vendors from being penalized for accepting deferred payments made as a result of an agreement with businesses who are facing financial difficulties due to the COVID-19 pandemic. The Act provides both landlords and vendors with an incentive to help tenants avoid declaring bankruptcy. Ultimately, landlords also benefit under the Act, which avoids clawbacks if a tenant cannot avoid bankruptcy.

Despite its advantages, 547(j) has limited application. The statute only applies to landlords of commercial property as well as entities who supply goods and services under existing contracts. Consequently, the exception does not apply to lenders, who are often secured and can raise various other defenses in response to recovery. To fully utilize 547(j), landlords should make sure to sufficiently document deferred payments.

With an appreciation of how preferred payments work, businesses should remember that there are several strategies they can follow to minimize their risk of being exposed to preferred payments, which include:

• Creditors should take action to establish open lines of communication with clients addressing the payment of invoices. This way, if timely payments are not made, routine demands to collect on the due amount can be made. Creditors can benefit from creating consistent payment histories as well as policies about how to handle default notices.
• To the degree that a customer falls behind, creditors should not hesitate to discuss cash on delivery terms as a required term for future deliveries. Taking these steps early on in the process will help to establish that these actions are part of a regular course of dealing. Landlords should also make sure to adequately address these situations upfront.

Speak with a Knowledgeable Bankruptcy Lawyer

While the bankruptcy process is often nuanced, an experienced bankruptcy attorney can help you navigate this process. Contact attorney Melanie Tavare today to schedule a free case evaluation and discuss how to best achieve your bankruptcy goals.