MASSACHUSETTS: An Introduction to Bankruptcy/Restructuring

Are ‘Mothball’ Motions Mothballed, Or Are They The New Normal?

By Sunni P. Beville, Shari I. Dwoskin, and Michael W. Reining, Brown Rudnick LLP

Sunni P. Beville is Managing Director of Brown Rudnick’s Dispute Resolution & Restructuring Department and a Partner in the Bankruptcy & Corporate Restructuring Practice Group. Shari I. Dwoskin and Michael W. Reining are Associates in Brown Rudnick’s Bankruptcy & Corporate Restructuring Practice Group.

As stores across the country were being shuttered due to COVID-19 restrictions and operating cash became scarce, retailers began negotiating various types of rent relief with their landlords, including deferrals, abatement and lease terminations. Those retailers that had already filed for bankruptcy protection under Chapter 11, or that were about to do so, had a different tool in their belt — the ability to “mothball” operations.

Typically, debtors in bankruptcy must “timely perform” all of their obligations under commercial leases until such lease is assumed or rejected, pursuant to Section 365(d)(3) of the Bankruptcy Code. While debtors do renegotiate their leases in bankruptcy, landlords generally can rely on receiving timely and complete rent payments while such negotiations are ongoing.

Retail and restaurant debtors (and their lenders) were thus faced with a serious quandary during the pandemic. Short-term cash flow restrictions could prevent them from making timely rent payments, which could quickly lead to administrative insolvency even for companies that had longer-term value potential. To combat this issue, retail and restaurant debtors used a variety of strategies ranging from a complete suspension (or “mothballing”) of cases to targeted 60-day rent deferrals. While we might have expected such strategies to abate along with pandemic restrictions, instead we have seen an expansion of what constitutes “cause” for debtors to receive extensions of their obligations to “timely perform” under their leases. Post-pandemic, therefore, “mothball” motions, or some variety thereof, may become the new normal.

Early Pandemic 

Retail debtors that filed either before the outbreak of COVID-19 or early in the pandemic quickly found themselves in a serious predicament — their carefully planned and budgeted Chapter 11 cases were threatened with derailment when stores were forced to close and consumer spending abruptly plummeted. In the spring of 2020, several such debtors sought to temporarily suspend (or “mothball”) their Chapter 11 cases, in part or in full. These debtors relied on the equitable powers of bankruptcy courts granted by Section 105 of the Bankruptcy Code, and on a second, seldom-used provision of the Bankruptcy Code. Section 305(a) permits a bankruptcy court to “suspend all proceedings” in a Chapter 11 case if “the interests of creditors and the debtor would be better served by such . . . suspension.”

These attempts to “mothball” cases met with varying degrees of success. Craftworks Parent LLC, Modell’s Sporting Goods, Inc. and Art Van Furniture, LLC all filed for Chapter 11 protection in early March 2020, just days before state and local governments began to issue stay-at-home orders and social distancing guidelines. In the fourth week of March, with operations heavily impacted by these restrictions, each debtor sought “mothball” relief from the expenses of administering a bankruptcy case.

Craftworks filed a motion under the Section 105 of the Bankruptcy Code asking for temporary case procedures to be put in place that would impose a “meet and confer” requirement on all parties prior to engaging in motion practice. After the court announced that such procedures were “well beyond any relief” he would be likely to grant, the debtors proposed, and the court entered, an order approving case procedures that, among other things, imposed a 30-day freeze on motions for relief from stay.

Modell’s stretched further: filing their motion under Sections 105 and 305, they requested a 30-day suspension of their bankruptcy cases, including approval of a modified budget under which rent would be deferred. The court, finding that “cause” was established by, among other things, the impact of the newly imposed restrictions on the debtors’ store-closing sales, not only granted the debtors’ motion, but subsequently extended the initial 30-day suspension for a total of a further 45 days.

Similar to Craftworks and Modell’s, Art Van Furniture announced that it would be seeking court authorization to put its case into “stasis or certainly life support mode over the next six weeks or so.” However, unlike Craftworks and Modell’s, Art Van Furniture found itself unable to reach agreement with its senior secured lenders on the terms of such “life support” and was forced to convert its case to Chapter 7.

Pier 1 Imports employed a different approach. Pier 1 had filed its Chapter 11 cases in mid-February 2020, with a restructuring support agreement in place with its term lenders that allowed for the possibility of either a reorganization or a restructuring and included a heavily negotiated budget and timeline for the bankruptcy cases. By the time pandemic restrictions were put in place, Pier 1 had closed certain stores, was in the process of conducting going-out-of-business sales in others, and was negotiating rent deferrals with all of its landlords. The restrictions mandated the closing of 80 additional stores, and Pier 1 elected to temporarily close the remaining 461 stores due to health and safety concerns and furlough most employees to preserve liquidity.

Because the pandemic significantly altered the development and timing of Pier 1’s bankruptcy cases, Pier 1 and its term loan lenders negotiated a “Limited Operation Period” wherein Pier 1 would continue to pay certain critical expenses under a modified budget and delay or defer rent payments owing to landlords who had not voluntarily consented to a deferral. To the extent that any payment was deferred, the debtors would “make reasonable best efforts to make such payment within 45 days following the Limited Operation Period.” Pier 1 sought approval for this approach under the court’s equitable powers pursuant to Section 105. Pier 1’s landlords objected, arguing that the debtors were seeking to treat landlords differently from other administrative priority creditors in order to pressure the landlords to grant rent deferrals and abatements. The court granted the motion, holding that landlords were entitled to an administrative claim for any deferred rent (which could be paid at the end of the case), and because Pier 1 would continue to pay the costs of utilities and insurance for which it was liable under its leases, landlords were adequately protected and would not be prejudiced by the delay.

Mid-Pandemic 

Debtors who filed Chapter 11 cases after the initial shock of the pandemic but while mandatory closures and/or occupancy limits were in place employed a different strategy: they asked for 60-day rent suspensions under Section 365(d)(3) of the Bankruptcy Code, rather than file more open-ended “mothball” motions under the courts’ equitable powers. Section 365(d)(3) permits a court to extend, “for cause”, the debtor’s obligations to timely perform under commercial leases. Retailers and restaurants such as The Paper Source, True Religion, J.C. Penney, J. Crew, and Chuck E. Cheese all cited the numerous state orders and guidelines that precluded or limited operations as “cause” for extending time to perform under leases for 60 days after the petition date. Each motion was granted. However, unlike Pier 1, where the obligation to repay deferred rent was deemed an administrative expense payable at the end of the case, these debtors’ obligations were only suspended for 60 days, and, in some cases, such debtors were required to repay in full all deferred rent upon the expiration of the extension period (unless otherwise abated or deferred by agreement with the landlords).

Of the rent suspension motions filed in these mid-pandemic cases, True Religion’s stands out in two ways. First, True Religion admitted that it did not have the liquidity to pay post-petition rent as it came due. Second, True Religion’s proposed DIP financing required the entry of an order suspending its rent obligations for 60 days. In other words, the bankruptcy court was faced with the choice of granting the motion, or having the debtors default on their DIP financing. While the order granting the motion did not specifically reference this in its finding of cause, it would not be surprising to see more DIP lenders condition funding on rent suspensions in the future.

Later Pandemic 

Stay-at-home orders were lifted in most states by spring of 2020, but the threat of renewed closures due to resurgence of the virus continued to loom for several months, and occupancy limits remained in place in many states throughout 2020. As vaccines began to be developed, however, a path toward the abatement of restrictions (if not the end of the pandemic itself) became clear in the second half of 2020, even as cases were rising.

Retail and restaurant debtors continued to file rent suspension motions under Section 365(d)(3), but the circumstances cited as cause for relief began to shift. While admitting that its stores had reopened, Ascena Retail Group (the parent company behind Ann Taylor, LOFT, Lou & Grey, Lane Bryant, and Cacique) cited an expected decrease in customer traffic compared to prior periods, as well as tightened trade terms in its motion. Ruby Tuesday, on the other hand, noted in its motion that while its restaurants were open and offering full dining services, it was operating under continued capacity restrictions and that paying rent for the first 60 days of the case would severely strain its resources.

Ruby Tuesday’s motion was granted, further expanding the set of circumstances that constitute “cause” under Section 365(d)(3). Ascena, on the other hand, withdrew its motion as part of a global settlement with its official creditors’ committee in connection with its Chapter 11 plan.

Conclusion 

Ascena’s strategy could become more common for retail debtors in the post-pandemic world. As courts have shown themselves willing to grant 60-day rent suspensions even as pandemic restrictions are lifted, landlords may opt to come to the negotiating table rather than risk a 60-day suspension of payments or an even broader “mothball” motion.