If a company decides to break a lease, it would be on the hook for the greater of one year’s rent, or 15 percent of the remainder of the lease — which could be a significant payout on a 30-year lease, the turnaround expert says. Under the old law, debtor liability was limited to one year on a broken lease.
Perhaps more important, the new law reclassifies back rent as an administrative claim rather than as an unsecured debt. As an administrative claim, back rent takes a priority position in the bankruptcy-creditor hierarchy, landing behind secured debt in the payout queue but leapfrogging ahead of unsecured creditors. Since unsecured debt is paid after the reorganization plan is finalized, reclassifying rent as an administrative claim will force bankrupt companies to shell out a whole lot more in upfront funding.
• More upfront funding. Generally, administrative claims are the costs incurred to run a business while it’s in Chapter 11. Those expenses include wages, taxes, and legal costs. By hiking the number of claims that qualify as administrative, the amendments essentially force insolvent companies to generate more upfront cash, according to Schneider. For bankrupt companies, generating cash almost always requires selling off assets, which can deplete a company’s value and potentially hurt its chances of emerging from bankruptcy, he says.
Several provisions of the act will require insolvent companies to pony up more money or return inventory before reorganization plans are set. For example, a change to Section 503(b)(9) of the code will grant administrative-claim status to any goods shipped within 20 days of a company’s filing for bankruptcy, as long as the shipment was made during the normal course of business. Although “the normal course of business” is a subjective term, attorneys agree that the criterion is very broad and includes any regular commerce between a vendor and the insolvent company.
The new administrative status entitles the trade creditor to immediately get 100 cents on the dollar for the shipped goods, rather than waiting until the reorganization plan is finalized — as holders of unsecured-debt claims must do. In practical terms, the priority status affords creditors two benefits: Once again, the creditor is pushed ahead of unsecured-debt holders in the payout pecking order, and the creditor must be paid in full. Generally, unsecured-debt holders get a much smaller percentage of what they’re owed, notes Schneider.
The new law also helps trade vendors stuck with unpaid invoices for goods received by corporate bankruptcy filers. Section 546(c) expands the administrative-claim status to cover goods received by debtors within 20 days of filing for bankruptcy. Previously, the claims period was 10 days. What’s more, trade creditors have the right to reclaim any goods in the possession of an insolvent company that were received within 45 days of the Chapter 11 filing. The reclamation period used to be 10 days.
Further, an amendment to Section 366 of the code states that companies in Chapter 11 are required to provide upfront assurance via such things as cash deposits, letters of credit, certificates of deposit, or prepayments to utility companies. That will enable the company to pay electric, heat, and water bills while it reorganizes. In the past, “assurance” of payment was left undefined and did not require cash deposits.