Restructuring

Contributed by Amy B. Price
On June 4, 2013, the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 held a field hearing, hosted by the New York Institute of Credit, at the New York Hilton.  The hearing focused primarily on the Bankruptcy Code’s treatment of two categories of contracts: (1) leases of non-residential real property and (2) licenses of intellectual property.  A panel of witnesses, comprised of attorneys and professionals, provided oral testimony—supplementing written statements they had previously submitted to the Commission—on a number of issues, including whether the 210-day time period to assume or reject leases of non-residential real property in section 365(d)(4) of the Bankruptcy Code prevents retailer debtors from successfully reorganizing.  In this first part of our two-part series on the hearing, we summarize the testimony and discussions concerning potential revisions to section 365(d)(4).
Background
Over a year ago, Geoffrey Berman, the president of the American Bankruptcy Institute, set out to assemble a group of chapter 11 practitioners, academics and bankers to study the need for comprehensive chapter 11 reform.  The result was the formation of the Commission—a committee of 21 of the restructuring community’s “best and brightest,” as described in the opening remarks of Robert J. Keach and Albert Togut, the Commission’s Co-Chairs.  Weil’s own Harvey Miller is a member of the Commission, although he was not one of the Commissioners who participated in the June 4 hearing.  The opening statement of Commissioners Keach and Togut also provides an instructive overview of some of the reasons why many believe that the Bankruptcy Code, as amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), needs to be reworked.  For example, since the 1978 iteration of the Bankruptcy Code, the use of secured debt has proliferated, the market for distressed debt and claims trading practices has expanded, companies are more dependent on contracts and intellectual property than the “hard assets” of yesteryear, and today’s “debtor” is often a complex interrelated web of entities, rather than a single entity.  With these issues in mind, the Commission selected topics for initial study, and for each topic, appointed an advisory committee to research the topic and potential for reform.  The field hearing process is a key part of the Commission’s reform efforts.  Last year, the Commission conducted hearings across the country, gathering testimony from more than 20 witnesses on a variety of topics.  By the end of 2013, the Commission will have held at least eight more hearings, reaching each judicial circuit in the United States.  The Commission also accepts written submissions from individuals not able to testify at the hearings.
The June 4 Hearing
After a brief introduction by Commissioners Keach and Togut, the June 4 hearing jumped right into the first substantive topic: the Bankruptcy Code’s treatment of leases of non-residential real property.  The witness panel included Lawrence C. Gottlieb, Esq., a partner at Cooley, LLP; Elizabeth I. Holland, Esq., the CEO of Abbell Associates, on behalf of the International Council of Shopping Centers; and David L. Pollack, Esq., a partner at Ballard and Spahr, LLP, each of whom represents divergent interests with respect to the Bankruptcy Code’s treatment of non-residential leases.
By way of background, BAPCPA amended section 365(d)(4) of the Bankruptcy Code to include a maximum 210-day time period in which a debtor must assume or reject a commercial real estate lease. In particular, section 365(d)(4) provides that a non-residential real estate lease under which the debtor is a lessee is deemed rejected if it is not assumed by the debtor by the earlier of (i) 120 days after the petition date or (ii) confirmation of a plan, and courts are authorized to extend the 120-day period for up to an additional 90 days for cause shown.  Extensions beyond the 210-day period can be obtained only upon the written consent of the landlord.  Prior to BAPCPA, a debtor had 60 days to decide whether to assume or reject its non-residential real estate leases, subject to extension by the court “for cause,” and there was no limit on the duration or number of extensions that could be sought. Significantly, additional extensions of the deadline to assume or reject did not require the lessor’s consent.  The BAPCPA amendment to section 365(d)(4) has been controversial since it was passed.  The Commission’s key concern, as expressed through its questioning of the witness panel, is that the 210-day limitation may be a key factor that prevents retail debtors from successfully reorganizing.
Although the witnesses unanimously agreed that the number of successful retail reorganizations has declined since BAPCPA was enacted, they disagreed on whether the 210-day limitation has contributed to the decline and that amending this provision will facilitate the successful reorganization of retail entities.
Based on his experience representing retail debtors and statistical studies of retail bankruptcies, Gottlieb, the first witness to testify, stated that he supports reform of section 365(d)(4).  Gottlieb posited that the 210-day limitation in section 365(d)(4) hinders retailers from successfully reorganizing because it prevents debtors from satisfying their liquidity needs during chapter 11.  In particular, lenders—already wary from the prepetition liquidity crisis that likely drove the debtor into bankruptcy—are reluctant to extend enough postpetition financing to facilitate the debtor’s reorganization.  According to Gottlieb, lenders prefer a single course when a retailer files: provide only as much postpetition financing as is necessary to fund an immediate 363 sale or liquidation through a “going out of business” (“GOB”) sale.  This pattern can be linked to the fact that today, most retailers have heavily “liened up” inventory, and a lender’s advance rate generally is based on the price for which the lender believes it can liquidate the inventory in a GOB sale. Thus, Gottlieb explained, retailers know what they need to recover and they know they need to recover that in a GOB sale.  The risk to the lender is that, if the debtor rejects the lease as of day 210, the lender loses the most commercially attractive outlet in which to liquidate its inventory: the retail store itself.  As a result, even prior to the debtor filing its petition, its lenders may agree to provide a DIP loan, but will require that the debtor sell the company or its assets in a 363 sale within a limited time frame or risk liquidation.  Although such DIP loans may have varying milestones or advance rates, their effect is the same: reorganization is not a viable option for the debtor.  Furthermore, according to Gottlieb, very few debtors consult with their landlord when they are negotiating their DIP loans or after because there is no time to do so.  Consequently, the lenders have sealed the debtor’s fate even prior to the petition date.  A GOB sale takes about 90-100 days to effectuate, in addition to the 30 days to obtain bankruptcy court approval of the sale.  At best, that leaves only about 60-90 days into the bankruptcy case for a debtor to finalize a reorganization process before the GOB sale must be effected.  This truncated time frame is even more problematic because of the nature of retail businesses, the vitality of which can be measured only in a full cycle that includes the end-of-the-year holiday season.  At bottom, Gottlieb’s testimony suggests that only lenders benefit from the current scheme.  Unsecured creditors are left with the minimal liquidation value of the inventory, and thousands of employees lose their jobs in the course of the liquidation.  Gottlieb’s paper provides that, in the Circuit City and Linens ‘n Things cases alone, 50,000 jobs were lost.
Gottlieb’s overall message is that the restructuring community, and the Bankruptcy Code itself, should promote the reorganization of retailers, in part because they are an important source of jobs.  In his view, this goal can be furthered by expanding the 210-day period to alleviate the pressure that lenders apply to retailer debtors and provide such debtors breathing room to develop a workable reorganization plan, including time to decide whether to assume or reject their leases.  To view Gottlieb’s full paper, click here.
Adopting a position contrary to Gottlieb, Holland presented the perspective of shopping center owners in connection with retail bankruptcy filings.  In particular, Holland disagreed that the 210-day limitation has been a primary contributor to recent retail liquidations.  Instead, Holland cited other key challenges confronting retailers, including changes in inventory finance, shifts in consumer shopping patterns, and the advent of online retail.  In Holland’s view, these factors, and not the Bankruptcy Code, are the key sources of concern for the retail industry and stand in the way of successful retail reorganizations.  Interestingly, in her draft written testimony, Holland states that “[t]he current debtor-in-possession financing product has significantly—and negatively—altered the course of recent retail bankruptcies and is a fundamental cause of retail liquidations.”  Unlike Gottlieb, however, Holland does not link the unavailability of DIP financing for retailers to the 210-day limitation in section 365(d)(4).  Moreover, she asserts that BAPCPA’s changes to section 365(d)(4) promote the stability of the commercial real estate market and prevent the deterioration of shopping center properties by preventing a domino effect within a shopping center when one retailer fails.  In short, Holland posits that amending the 210-day provision will not help retail debtors, who are plagued by various other ailments, and that it would be unwise to give tenants a longer amount of time to assume or reject a lease, thereby prolonging the chapter 11 process and exacerbating administrative costs.
Pollack was the final witness to testify on the issue of non-residential leases.  Like Holland, Pollack, who primarily represents landlords in bankruptcy cases, does not believe that BAPCPA’s amendment to section 365(d)(4) has had any material effect on the ability of a retailer to reorganize.  Pollack similarly cites other hurdles that retailers face, including the economy, business plans and lender control and believes that granting debtors more time to assume or reject commercial real estate leases will not save most retail debtors from liquidation.  To view Pollack’s full paper, click here.
At the close of the witness testimony, a probing question and answer session ensued between the panelists and the Commissioners.  In particular, the Commissioners seemed skeptical that 210 days could provide enough time for a large retailer with potentially hundreds of leases to evaluate strategically the value of all of their leases.  Moreover, the Commissioners expressed doubt that 210 days is enough time to craft and implement a new marketing plan or business plan, especially given that the retailers’ business models are so heavily weighted towards year-end.  Furthermore, they noted it may be hard to restore lenders’ confidence in the company’s future in such a short amount of time.
All told, the witnesses and Commissioners agreed that revising the Bankruptcy Code is a balancing exercise.  As one Commissioner noted, the 210-day limit is a rather “blunt instrument,” and secured lenders seem to be at the helm of the current bankruptcy process.  At the same time, landlords need to know when their property will be returned so that they can plan accordingly.  The participants at the hearing did not elaborate on the details of what a revised section 365(d)(4) would look like, but the Commissioners welcomed concrete problem-solving suggestions from the witnesses.
We encourage you to watch the hearing video and review the written submissions, all of which can be accessed here.  Also stay tuned for the second part of our hearing coverage, addressing potential reform of the Bankruptcy Code’s treatment of intellectual property licensing agreements.