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Lessee Bankruptcy Webinar Current Issues for Lessors and Lenders Robert S. Bernstein, Moderator Panelists: Jay L. Welford, Jaffe, Raitt, Heuer & Weiss,

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Presentation on theme: "Lessee Bankruptcy Webinar Current Issues for Lessors and Lenders Robert S. Bernstein, Moderator Panelists: Jay L. Welford, Jaffe, Raitt, Heuer & Weiss,"— Presentation transcript:

1 Lessee Bankruptcy Webinar Current Issues for Lessors and Lenders Robert S. Bernstein, Moderator Panelists: Jay L. Welford, Jaffe, Raitt, Heuer & Weiss, P.C. Harry W. Greenfield, Buckley King Kirk B. Burkley, Bernstein Law Firm January 11, 2012 Robert S.Bernstein Harry W. Greenfield Jay L. Welford Kirk B. Burkley

2 LEAN Webinar LATEST ASSUMPTION/REJECTION CASES AND CONCERNS By, Jay L. Welford, Esq. Jaffe, Raitt, Heuer & Weiss, P.C Franklin Road, Ste Southfield, MI

3 I.What is a lease, for bankruptcy purposes? A. The term executory contract is not defined by the Bankruptcy Code but has been interpeted to include lease obligations. The legislative history, however, refers to the definition proposed by Professor Countryman in Executory Contracts in Bankruptcy, Part I, 57 Minn. L.Rev. 436, 460 as follows: 1."A contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other." Executory Contracts in Bankruptcy, Part I, 57 Minn. L.Rev. 436, 460. B.The term lease also is not defined in the Bankruptcy Code. However, the legislative history indicates that a lease disguised as financing should not be treated as a lease. S. Rep. No , 95th Cong., 2d Sess. 64 (1978). The terms "security", "security agreement" and "security interest" are defined by the Bankruptcy Code. See 11 U.S.C. §§ 101(49), (50) and (51).

4 II.Section 365 of the Bankruptcy Code governs leases. A.Section 365 is "intended to relieve the estate of the debtor's burdensome obligations, while providing a means whereby the debtor can force others to continue to do business with it at a time when a bankruptcy filing might otherwise make them reluctant to do so. In re Chateaugay Corp., 10 F.3d 944 (2d Cir. 1993). Another purpose is to effect a breach of the debtor's agreements thereby allowing the injured parties to file claims in the bankruptcy case. In re Register, 95 B.R. 73 (Bankr. M.D. Tenn. 1989).

5 III.What time limitations are applicable in a bankruptcy case? A.In Chapters 9, 11, 12 or 13, the debtor may assume or assign an executory contract or lease anytime prior to confirmation of the plan. 11 U.S.C. § 365(d)(2). B.In a Chapter 9, 11, 12 or 13, the debtor may reject a lease at any time up until confirmation of its plan. C.In Chapter 7 case, a lease must be timely assumed or assigned. 11 U.S.C. 365(d)(1). D.In a Chapter 7 case, a lease is deemed rejected if it is not assumed within 60 days of the date of the order for relief (usually the filing date), although the 60 days may be extended for cause, if the motion for extension is heard/determined within the first 60 days. 11 U.S.C §365(d)(1). PRACTICE TIP: IF THE CASE IS A CHAPTER 7 CASE, CALENDAR THE 60 TH DAY THAT THE LEASE WILL BE DEEMED REJECTED. IF THE LEASE IS NOT REJECTED PRIOR TO THAT DATE, THIS WILL THEN TRIGGER YOUR RIGHT TO SEEK THE RETURN OF YOUR EQUIPMENT.

6 IV.Postpetition Entitlements Prior to Assumption/Rejection. A.In a Chapter 11 case, the debtor must commencing making payments and otherwise comply with lease terms (such as payment of taxes, etc.) under a lease on the 61 st day after the bankruptcy petition was filed. 11 U.S.C. § 365(d)(5). 1.Nonperformance by the debtor gives the lessor grounds to move the court to lift the automatic stay and seek a determination that the lease should be deemed rejected based on the debtor’s inaction. Sturgis Iron & Metal Co., Inc., 2009 WL , *20 (Bankr. W.D. Mich. 2009). 2.After day 60, the lessor may file a pleading with the court requesting that the first sixty-days of rent be paid as an administrative expense. 3.Some courts will grant the relief; others will allow the debtor to roll the payment into its plan and pay it when all other Chapter 11 administrative expenses are to be paid. 4.To confirm a plan, a debtor must pay all administrative expenses in full upon confirmation, unless the administrative claimant agrees otherwise. 5.If the case is a Chapter 11 case, but the property is leased to an individual for personal, family or household purposes, there is no requirement to commence lease payments after the first sixty-days.

7 IV. Postpetition Entitlements Prior to Assumption/Rejection. B.In a chapter 7 case, the trustee does not have the same duty to commence making payments on the 61 st day. In most cases a trustee will immediately seek to reject the lease and eliminate the accrual of administrative lease obligations, since in almost all Chapter 7 cases the trustee is not operating the business. PRACTICE TIP: CALENDAR THE 61 ST DAY AFTER THE CHAPTER 11 FILING TO FOLLOW UP ON WHETHER PAYMENT HAS COMMENCED BY THE DEBTOR. IF NOT, HAVE YOUR COUNSEL FILE A MOTION TO COMPEL PAYMENT AND A DETERMINATION THAT THE LEASE SHOULD BE REJECTED.

8 IV. Postpetition Entitlements Prior to Assumption/Rejection. C.In determining what rent must be paid commencing on day 61, there is a split of authority. This so called “stub rent” rule addresses whether a full month’s rent or only a pro-rata amount of a month’s rent is due for the rent falling due on day 61. In In re Koenig Sporting Goods, Inc., 203 F.3d 986 (6th Cir. 2000), the court held that rent should not be pro-rated, such that rent for the entire month must be paid, even if the 61 st day fell on a later date during the month. However, in In re Stone Barn Manhattan LLC, 2008 Bankr. Lexis 3260, 2008WL (Dec.17, 2008) (f.k.a. Steve & Barry's Manhattan LLC), the court held that the rent would be pro-rated for the month in which payments were first due. D.A lessor is not entitled to suspend any performance requirements which it has under the lease while the debtor makes the determination whether to assume or reject the lease. The lessor’s recourse is to: (a) seek to compel payment of the administrative rent; and (b) file a motion seeking to compel an earlier determination regarding assumption or rejection, if warranted and supportable by good cause.

9 V.Rejection. A.Effect of rejection. 1.Rejection constitutes a breach of the lease. 11 U.S.C. § 365(g). 2.Rejection does not invalidate or terminate the lease. In re Continental Airlines, 981 F.2d 1450 (5th Cir. 1993). B.The timing of the rejection and any prior assumption of the lease affects when the lease is deemed to have been rejected in a case under Chapter 11, 12 or 15: 1.If the rejection occurs prior to assumption, the breach is deemed to have occurred immediately prior to the date of the filing of the petition. 11 U.S.C. §365(g)(1). 2.Where rejection occurs after assumption and the case has not been converted, then the breach occurs at the time of rejection. 11 U.S.C. § 365(g)(2)(A). 3.If a case has been converted and the assumption occurred prior to conversion, the breach occurs immediately before the date of conversion. 11 U.S.C. § 365(g)(2)(B)(I) 4.If a case has been converted, and the assumption occurred after conversion, the breach occurs at the time of rejection. 11 U.S.C. § 365(g)(2)(B)(ii). 5.If the debtor is involved in an individual Chapter 11 case or in a Chapter 13 case and if the lease is not assumed in the plan, the lease is deemed rejected as of the conclusion of the hearing on confirmation and the stay automatically terminates. 11 U.S.C. §365(p)(3)..

10 V.Rejection. C.Whether the damages resulting from rejection are an unsecured claim versus an administrative claim depends on whether the lease was previously assumed. 1.If the lease was not assumed prior to being rejected, the damages, other than lease payments due from and after the filing date, is generally deemed to be an unsecured claim. Damages include the rent remaining due under the lease (less only the amount paid post- bankruptcy) plus applicable termination penalties, taxes, etc. 2.If the lease was assumed prior to being rejected (which could happen based on the debtor failing in its reorganization, the debtor later shedding a division or otherwise being too optimistic in assuming leases too early etc.), the damages are entitled to administrative expense status. In re Klein Sleep Products, 78 F. 3d 18, 28 (2d Cir. 1996); In re Merry-Go-Round Enterprises, Incorporated, 180 F.3d 149, 156 (4' Cir. 1999).

11 V.Rejection. D.The effective date of rejection is important because the creditor is entitled to an administrative expense claim from the date of the petition to the date of rejection. At least two circuits have found that bankruptcy courts have the equitable authority to approve rejection retroactively. In re At Home Corp., 392 F.3d 1064 (9th Cir. 2004)(lease rejected retroactively to the filing date of the motion). In re Thinking Machines, 67 F.3d 1021, 1028 (lst Cir. 1995)(accord). PRACTICE TIP: IF YOU RECEIVE A MOTION TO REJECT YOUR LEASE, REVIEW IT TO DETERMINE IF THE DEBTOR IS SEEKING A RETROACTIVE REJECTION. IF SO, OBJECT IF YOU ARE IN A CIRCUIT WHERE RETROACTIVE REJECTION IS NOT PERMITTED.

12 V.Rejection. E.Cap on damages for rejection of leases. 1.There is no cap on the damages assertable based on the breach of an equipment lease (for real property leases, there is a cap, equal to the greater of one year’s rent or 15% of three year’s rent). 2.In determining the damages, any payments due post- bankruptcy filing until the date the lease is rejected are treated as administrative expenses, and the balance are treated as an unsecured claim. F.The automatic Stay under §362(a) is automatically terminated if a lease of equipment is rejected or not timely assumed by the trustee. 11 U.S.C. §365(p)(1).

13 VI. Assumption A.The actions a debtor or trustee must take to assume a lease depends on the type of lease at issue. 1.A debtor in a Chapter 7 is not required to seek court approval or other court action when assuming a lease (usually of a motor vehicle) pursuant to 11 U.S.C. §365(p)(2). Under this subsection, the debtor may notify the lessee of its desire to assume the lease. The lessor may accept or decline the request; if it accepts, the lessor may insist that all outstanding defaults be cured as a condition of assumption. If assumed, the debtor and not the Chapter 7 estate will become obligated going forward under the lease. 2.In all other instances, a debtor is required to seek court approval to assume a lease.

14 VI. Assumption. B.What standard must be met before a lease may be assumed? 1.To assume a lease, the debtor must meet the following requirements: 1) cure any default that currently exists or provide adequate assurance of prompt cure of the default; 2) provide adequate assurance of prompt compensation for any monetary loss; and 3) provide adequate assurance of future performance of the contract. C.What about contracts consisting of several distinct agreements? 1.In re Gardinier, 831 F.2d 974 (11th Cir. 1987), was the first circuit to develop a test to determine the composition of an executory contract or lease - whether a contract or lease may be separated into more than one contract or lease for the sake of assuming one part and rejecting another.

15 VI. Assumption. 2.Herein, the court considered whether a provision to pay a brokerage commission, contained within a purchase and sale agreement, constituted a separate and distinct agreement subject to assumption or rejection pursuant to § In holding that the brokerage commission provision constituted a separate agreement between the parties, the court identified three factors it considered in determining severability: (i) whether the nature and purpose of the obligations differ, (ii) whether the consideration for the obligations is separate and distinct, and (iii) whether the obligations of the parties are interrelated. 4.Other courts have held that a debtor who assumes a lease must assume the lease in its entirety. In re Cafe Partners/Washington, 90 B.R. 1 (Bankr. D.C. Cir. 1988).

16 VI. Assumption. 5.Where a master lease is involved with several schedules, debtors have sought to reject certain lease schedules and assume others. Depending on the jurisdiction where the case is pending, the debtor may or may not be successful in that effort. PRACTICE TIP: IN STRUCTURING YOUR LEASES, GIVE CONSIDERATION TO WHETHER YOU WANT TO USE A MASTER LEASE AND SEVERAL SCHEDULES AS NEW EQUIPMENT IS LEASED, OR INDIVIDUAL LEASES. HAVING A MASTER LEASE MAY PROHIBIT A DEBTOR FROM CHERRY-PICKING AMONG THE MORE ATTRACTIVE LEASE SCHEDULES AND WALKING AWAY FROM THE MORE BURDENSOME ONES.

17 VI. Assumption. D.A debtor or trustee’s determination whether to assume or reject a lease is within the business judgment of the debtor or trustee. 1.A court is required to determine if the debtor has exercised correct “business judgment” in its analysis of a lease’s rejection or assumption. The court is to look to the terms of the underlying contract, as well as the circumstances of the debtor, such as the debtor’s need for the equipment, the ability to make the lease payments and whether another substitute for the leased equipment, if needed, is available at a lesser cost. PRACTICE TIP: MANY DEBTORS WILL SEEK TO NEGOTIATE THE TERMS OF AN EXISTING LEASE UNDER A THREAT OF REJECTION. BE PREPARED FOR SUCH A REQUEST.

18 VII. Assignment. A.Section 365(b) prescribes conditions that must be met for assignment of a lease where a default has occurred. 1.The debtor must cure any defaults in the lease and must provide adequate assurance of future performance before the lease may be assumed. In the Matter of U.L. Radio Corp., 19 B.R. 537, 541 (Bankr. S.D.N.Y. 1982). 2.The debtor must also provide adequate assurance of future performance by the proposed assignee of an assumed lease, before the lease may be assigned. In the Matter of U.L. Radio Corp., 19 B.R. at 541. a.Adequate assurance is determined by the circumstances of each case. In re Sapolin Paints, Inc., 5 B.R. 412, 421 (Bankr. E.D.N.Y. 1980).

19 VII. Assignment. B.A lease may be assigned notwithstanding any clauses in the lease restricting assignment. 11 U.S.C. § 365(f)(1). 1.The Bankruptcy Code also prohibits enforcement of clauses that modify or terminate the contract by virtue of its assignment. 11 U.S.C. § 365(f)(3). 2.Similarly clauses that condition assignment of the lease on the lessor receiving a portion of the debtor's profit from the assignment are prohibited. 11 U.S.C. § 365(f)(1). 3.Lease assignments are permissible, to assist the debtor's reorganization or liquidation efforts. In re Jamesway Corp., 201 B.R. 73, 78 (Bankr. S.D.N.Y. 1996). C.Non-assignable leases 1.Although 11 U.S.C. § 365(f) specifically invalidates restrictions on assignment, some types of contracts may not be assumed or assigned. Contracts for unique personal services, to extend credit, make loans, or issue securities are generally non-assignable under state law. In the Matter of U.L. Radio Corp., 19 B.R. at 541.

20 VIII.Sale Motions. A.Motion to assume and assign in connection with a sale motion. 1.It is becoming common place for a debtor in a Chapter 11 case to seek to sell its assets in what is called a Section 363 sale, which is a sale conducted under 11 U.S.C. §363 of the Bankruptcy Code. 2.Most purchasers at a Section 363 sale are looking for a turn- key operation, and so the sale motion will be accompanied by a motion seeking to assume and assign leases to the prospective buyer. 3.Usually the motion identifies all of the potential leases which may be assumed and assigned and states that the buyer will have a given number of days either prior to the hearing on the sale or after the hearing on the sale, to designate the leases it wishes to have assigned to it.

21 VIII.Sale Motions. 4.In conjunction with this list of leases will be a proposed list of cure amounts, which the debtor will assert constitutes the past due amounts owing to each lessor, needed to “cure” any existing defaults under the leases. 5.The motion will set a bar date by which each lessor must object to the cure amount. If no objection is raised, the amount designated by the debtor will be deemed to be the only past-due amount which must be cured in order for the lease to be assumed and assigned. PRACTICE TIP: IT IS THEREFORE CRITICAL THAT THE LESSOR PAY CLOSE ATTENTION TO ANY SECTION 363 MOTION, AS IT MAY INCLUDE A MOTION TO ASSUME AND ASSIGN A GIVEN LEASE AND WILL INCLUDE A BAR DATE FOR OBJECTING TO THE CURE AMOUNT. MANY LESSORS MISS THIS DEADLINE AND ARE LEFT WITHOUT RECOURSE FOR THE SHORFALL.

22 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas LEAN Webinar POTENTIAL IMPACTS OF SECTION 363 SALES ON THE RIGHTS OF PERSONAL PROPERTY AND REAL PROPERTY LESSEES AND LESSORS By: Harry W. Greenfield, Esq. Buckley King LPA 1400 Fifth Third Center 600 Superior Avenue, E Cleveland, Ohio

23 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Sometimes, a “Lease” Is Not Really a Lease. Five Factors used by the Seventh Circuit to characterize a lease vs. secured loan: 1. Does the “rental” payment equal the amount borrowed? 2. Is the final payment a balloon payment? 3. Is there a “hell or high water” clause? 4. Does prepayment end the obligations? 5. Does the “lessor” lose its interest at the end?

24 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Sometimes, a “Lease” Is Not Really a Lease. PRACTICE POINTER: A lessor should perfect its security interest under state law, such as the UCC (for personal property), if it is conceivable that someone might challenge whether the transaction is a secured loan masquerading as a lease -- otherwise, parties may sue to “recharacterize” the “lease” as a loan and to “avoid” the “unperfected” lien.

25 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Lessors or Lenders: The Effects of Transaction Recharacterization. Section 365 provides 3 options for lessors with respect to leases. The debtor may: Assume the lease (which entails curing various defaults, as well) and continue paying on it; Assume the lease and then assign it to another person, who assumes and is responsible for making future payments on it; or Reject the lease and (in most instances) turn the property over to the lessor / owner. See 11 U.S.C. § 365(a), (b), (f).

26 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Lessors or Lenders: The Effects of Transaction Recharacterization. Debtors under secured transactions have more options. The debtor may: Keep the property and pay for any diminution in its value. Any difference between the value and the debt is considered an unsecured claim. See 11 U.S.C. § 506(a). Protect the creditor’s interest by either making periodic payments, providing a replacement lien, or providing the creditor with the “indubitable equivalent” of its interest, but only once the creditor requests it and then only to the extent the value of the collateral decreases. See, e. g., 11 U.S.C. §§ 361; 362(d); 506(a). Restructure the secured debt in a Chapter 11 plan, by (for instance) extending the repayment period, changing the amortization schedule, reducing the interest rate, etc. See, e.g., 11 U.S.C. §§ 1123(b)(5); 1129(b)(2)(A).

27 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Lessors or Lenders: The Effects of Transaction Recharacterization. In relevant part, Section 363(f) provides: (f) The trustee [which includes debtors-in-possession in chapter 11 reorganizations] may sell property under subsection (b) or (c) of this section [363] free and clear of any interest in such property of an entity other than the [bankruptcy] estate, only if— (1) applicable nonbankruptcy law permits sale of such property free and clear of such interest; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. 11 U.S.C. § 363(f)

28 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Sale of “Leased” Property. The risk that a lessor’s or landlord’s property may be sold can exist even if the bankruptcy court has not yet decided whether the lease is a “true lease” or a secured loan. This is because a lawsuit regarding whether the “lease” is a “true lease” or a “loan” creates a “bona fide dispute” that triggers the power to sell under Section 363(f)(4). See, e.g., In re Daufuskie Island Properties, LLC, 431 B.R. 626 (Bankr. D.S.C. 2010); In re Robotics Vision Systems, Inc., 322 B.R. 502 (Bankr. D.N.H. 2005).

29 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Sale of “Leased” Property. “The goal of §363(f)(4) is to ‘allow the sale of property subject to dispute so that liquidation of the estate's assets need not be delayed while such disputes are being litigated.’” Daufuskie, 431 B.R. at 645

30 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Sale of “Leased” Property. Adding insult to injury, the asset purchaser – rather than a debtor or trustee – sometimes is the party with the greatest incentive to challenge whether a “lease” is actually a loan. In In re Gateway Ethanol, L.L.C., 415 B.R. 486 (Bankr. D. Kan. 2009), for example, the purchaser argued that the lease really was a security agreement, so that the purchaser could escape the obligations to make any future lease payments.

31 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Woes for Real Estate Tenants. Qualitech illustrated the power of Section 363(f) and its interplay with other Bankruptcy Code sections. Specifically, Section 365(h) provides that a tenant under a “rejected” real estate lease has the right to either: Treat the lease as being terminated (if the lease rejection would have that effect under the lease, non-bankruptcy law, or any other agreement), or Retain its rights under the lease (including the right to continued possession) for the remainder of the lease -- including any renewal or extension periods -- and offset future rent to reduce any damage caused by the debtor/landlord’s nonperformance after the lease is rejected. The Seventh Circuit noted in Qualitech that, in the face of a bankruptcy sale, non-debtor parties can seek “adequate protection” of their interests under Section 363(e).

32 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Woes for Real Estate Tenants. PRACTICE POINTER: At least in the Seventh Circuit, a real estate lessee that receives proper notice of a sale hearing, but that fails to appear and defend its leasehold rights (or fails to seek adequate protection of its interests), may find itself with no remedy and no one to pursue. And even if a commercial tenant does timely appear and defend its rights, it may lose anyway, as in MMH. Lessors and landlords must act diligently to defend their rights, or risk losing them.

33 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas Can a Lessor or Lessee “Undo” a Sale Order? Trying to “undo” a sale is an uphill battle. Sale orders typically enjoin pursuit of the purchaser for any assets or payment. Attempts to recover the proceeds from other creditors will be problematic and expensive. Sale orders typically are “final” orders that are largely immune from attack. The appeal time is short: only 14 days (subject to potential extension). Fed. R. Bankr. P. 8002(a). Section 363(m) protects good faith purchasers from a sale being unwound if the sale closes before a stay of the sale order is in place. Doctrines of finality, such as “equitable mootness,” likewise may bar a lessor’s litigation path.

34 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas So What Should a Lessor or Lessee Do? (More Practice Pointers.) If there is any doubt that a lease is a “true lease,” a real estate or equipment lessor should “perfect” its interest in the property under law - as if the lease is a security agreement or financing arrangement. This may discourage an opportunistic debtor-in-possession or trustee from trying to “tee up” a Section 363(f) sale by attacking the lessor’s interests as being an “unperfected” lien in disguise. Even taking these measures, though, will not stop a determined debtor-in-possession from trying to “recharacterize” a lease as a loan, if the debtor seeks to retain the affected property, restructure the “secured debt,” and, potentially, pay much less for it under a Chapter 11 plan than the promised “rent.”

35 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas So What Should a Lessor or Lessee Do? (More Practice Pointers.) Equipment lessors, commercial landlords, and commercial real estate tenants should diligently review ALL NOTICES AND PAPERS If a debtor or trustee seeks to “recharacterize” a real estate or equipment lease as a secured loan, it typically must commence an adversary proceeding to accomplish this. Fed. R. Bankr. P. 7001(2), (9). Lawsuits tend to draw a defendant’s close attention. Sometimes, though, the “lease vs. loan” issue can emerge in objections or other filings that may seem innocuous or that may appear to be directed against others.

36 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas So What Should a Lessor or Lessee Do? (More Practice Pointers.) Even if a debtor is not proposing adverse action, a lessor should make sure its interests are presented to the bankruptcy court in a timely and effective manner.

37 Cleveland. Columbus. Cincinnati. Atlanta Gainesville. Phoenix. Las Vegas So What Should a Lessor or Lessee Do? (More Practice Pointers.) For equipment lessors and lenders: If the transaction is a “true lease”: The non-debtor should file a motion to seek a date certain by which the lease must be assumed as part of the sale. The non-debtor should respond to any notice regarding the amount or timing of payment of any “cure” amounts. If the transaction is a financing lease: The “lessor” should seek adequate protection of its interests, including the right to “credit bid” the amount of its secured claim at any sale of its property. The “lessor” should consider seeking relief from stay or taking other action to protect its interests as a “secured creditor.” If the non-debtor is a commercial tenant whose landlord files for bankruptcy: The tenant should assert its rights under Section 365. The tenant should request adequate protection under Section 363(e).

38 LEAN Webinar Chapter 9 Municipal Bankruptcies and Impact on Lessors/Lenders By, Kirk B. Burkley, Esq. Bernstein Law Firm, P.C. 707 Grant Street Suite 2200 Pittsburgh, PA

39 A business approach to legal service tm. Chapter 9 A result of the Great Depression, in 1934 (Pub. L. No. 251, 48 Stat. 798 (1934)).Congress formulated the first version of Chapter 9 to protect debt laden cities and municipalities. Chapter 9 of Title 11 of the United States Code (the “Bankruptcy Code”) is only available to municipalities and provides municipalities protection from creditors while allowing the municipality to create a plan to restructure its debts. In the past, filing for Chapter 9 protection was considered a last resort because of the uncertain results for everyone involved including municipal employees and bondholders. In the current economic downturn, more and more debt laden cities and municipalities are finding themselves considering the Chapter 9 option.

40 A business approach to legal service tm. Chapter 9 Eligibility In order to be eligible for Chapter 9 protection several factors must be present. Those factors are found in Section 109(c) of the Bankruptcy Code. Upon the filing of a petition under Chapter 9, the bankruptcy Court will determine whether proposed debtor meets these requirements. The chief judge of the court of appeals for the circuit embracing the district in which the case is commenced shall designate the bankruptcy judge to conduct the Chapter 9 case.

41 A business approach to legal service tm. What is a Municipality? A municipality is defined as a "political subdivision or public agency or instrumentality of a state" (11 U.S.C. § 901). Municipalities include political subdivisions such as counties, parishes, cities, towns, villages, boroughs and townships. A municipality may also include public agencies or instrumentalities that are organized for the purpose of constructing, maintaining and operating revenue producing enterprises (Bankruptcy Act § 81(1), former 11 U.S.C. § 404 (1976); In re County of Orange, 183 B.R. (594)). In addition to being defined as a municipality, a proposed Chapter 9 debtor must also have specific state authorization to be a debtor under Chapter 9. D. A municipality must be financially insolvent to be a debtor under Chapter 9, meaning that the municipality cannot and has not been paying its debts as they come due.

42 A business approach to legal service tm. The Plan of Adjustment The plan of adjustment must provide for the restructuring of the municipality’s debts similar to a Chapter 11 plan of reorganization for private entities (both businesses and individuals). In Chapter 9, like Chapter 11, creditors holding impaired claims are entitled to vote to accept or reject the plan of adjustment. In order to be confirmed the plan must receive votes accepting the plan by 51% in number of creditors voting and 2/3 in dollar amount of votes cast, as well as satisfy all of the other Bankruptcy Code.

43 A business approach to legal service tm. A plan will only be confirmed if it satisfies the following criteria set forth in 11 U.S.C. § 943: (1) the plan complies with the provisions of this title made applicable by sections 103(e) (1) and 901 of this title; (2) the plan complies with the provisions of this chapter; (3) all amounts to be paid by the debtor or by any person for services or expenses in the case or incident to the plan have been fully disclosed and are reasonable; (4) the debtor is not prohibited by law from taking any action necessary to carry out the plan; (5) except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that on the effective date of the plan each holder of a claim of a kind specified in section 507(a)(2) of this title will receive on account of such claim cash equal to the allowed amount of such claim; (6) any regulatory or electoral approval necessary under applicable nonbankruptcy law in order to carry out any provision of the plan has been obtained, or such provision is expressly conditioned on such approval; and (7) the plan is in the best interests of creditors and is feasible (11 U.S.C. § 934(b)(1-7)).

44 A business approach to legal service tm. Benefits of Filing for Chapter 9 Bankruptcy Chapter 9 allows a municipality to restructure debt and rebuild with minimal effect as possible on the people. It also provides a path for repayment of creditors while discouraging citizens from taking direct legal action against the municipality. The Court cannot force a city to sell assets nor restrict the hiring of professionals such as accountants or lawyers or auditors. The normal restrictions on “disinterestedness” of professionals found in Section 327 of the Bankruptcy Code do not apply to Chapter 9. One of the most controversial, yet beneficial, aspects of Chapter 9 is a municipality’s ability to reject onerous collective bargaining agreements (“CBA”) with its unionized workforce.

45 A business approach to legal service tm. Effects on Lessors/Lessees Section 365 of the Bankruptcy Code applies in Chapter 9 proceedings. See 11 U.S.C. Section 901(a) However, Section 363 of the Bankruptcy Code does not apply in Chapter 9 cases. The Bankruptcy Court is not empowered to convert a case filed under Chapter 9 or force the Debtor to liquidate its assets. Section 365(g) still determines the time of the breach for a contract rejected under Chapter 9. Section 929 of the Bankruptcy Code provides that a lease to municipality shall not be treated as an executory contract or unexpired lease for the purpose of section 365 or 502(b)(6) solely by reason of it being subject to termination in the event the debtor fails to appropriate rent.

46 The only nationwide network of law firms specializing in lease enforcement and recovery Legal expertise Strategic locations Cost effective solutions Find out how LEAN can help your bottom line. Call 877-LEASE-LAW for a complimentary referral or visit us at

47 Questions? Thank You.


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