Bankruptcy

After Sunset of Higher Thresholds, Is Subchapter V Bankruptcy Still a Viable Option for Distressed Small Businesses?

By Anthony J. D’Artiglio

Historically, struggling small businesses looking to the Bankruptcy Code for salvation rather than liquidation had only one option: a proceeding under Chapter 11. Indeed, Chapter 11 has given countless companies the breathing room needed to reorganize and restructure their debts rather than close up shop for good. However, the costs, complexities, and often glacial pace of Chapter 11 proceedings made it too burdensome or even infeasible for many smaller companies, leaving them no choice but to call it a day and file a Chapter 7 bankruptcy petition to help them resolve their outstanding obligations. 

This shortcoming eventually drew the attention of legislators who, in 2019, established a new section of the Bankruptcy Code – Subchapter V of Chapter 11 – specifically designed to provide smaller businesses with a more viable and streamlined path to restructure their debts while maintaining operations. Unlike traditional Chapter 11 cases, Subchapter V does not require the formation of a creditors’ committee unless ordered by the court for cause. Instead, a single trustee is appointed who generally can move expeditiously to assist with the reorganization process. This omission significantly reduces administrative expenses and speeds up the proceedings. Additionally, Subchapter V cases typically move quicker than traditional Chapter 11 proceedings. The debtor must file a reorganization plan within 90 days of filing for bankruptcy, a much shorter timeframe than the flexible deadlines in conventional Chapter 11 cases. The expedited timeline encourages a quicker resolution and reduces the period in which the business is essentially in limbo.

When proceedings under this new chapter began in February 2020, eligibility was limited to entities with aggregate, noncontingent, liquidated, secured, and unsecured debts of no more than $2,725,625. A debtor must also be engaged in commercial or business activities to seek relief under Subchapter V, with at least 50% of its debts arising from these activities. 

Within weeks after the first Subchapter V petition was filed, however, the COVID-19 pandemic struck and spurred the federal government to take action on several fronts to address the crisis, including the passage of the CARES Act. That legislation, passed in March 2020, temporarily raised the debt threshold for Subchapter V eligibility to $7.5 million. Congress extended it several times thereafter, allowing thousands more businesses devastated by lockdowns to avail themselves of this critical new lifeline. 

And avail themselves they did. Between February 19, 2020, and September 30, 2023, Subchapter V proceedings accounted for approximately 30% of all Chapter 11 bankruptcy filings in the U.S., according to the American Bankruptcy Institute.

However, time expired on the last extension of the higher $7.5 million threshold on June 21, 2024. As such, the Subchapter V debt limit reverted to $3,024,725.

The result was unsurprising. As reported by Epiq AACER, a bankruptcy analytics firm: 

The impact of the lower debt eligibility limit on Subchapter V filings has been substantial. Between January 1 and June 21, 2024, there were 1,153 Subchapter V cases filed — an increase of 66.2 percent from the same period in 2023. Since then, 391 Subchapter V cases have been filed, an increase of only 4.5 percent from last year.

Only time will tell whether increased limits will be restored that helped thousands of small businesses survive and emerge from financial distress. Until and unless that happens, the failure to extend the higher thresholds for Subchapter V eligibility and the more limited availability of these proceedings make it much harder for small businesses to get back on their feet instead of having to liquidate their assets. That said, if you believe your distressed business may qualify under the lower threshold and want to find a way to move forward rather than liquidating, Subchapter V remains an avenue worth exploring.

If you have questions about or want assistance with a Subchapter V bankruptcy, or seek to pursue a Chapter 11 as cost-effectively as possible, please contact Anthony D’Artiglio.

Rite-Aid’s Shuttering of Numerous Stores Illustrates the Challenges Faced by Commercial Landlords When a Tenant Files for Bankruptcy

By Anthony J. D’Artiglio

Pharmacy giant Rite-Aid’s bankruptcy and proposed reorganization plans have had wide-ranging and cascading impacts from coast to coast. But perhaps the most immediate and acute effects of the company’s insolvency are felt by the commercial landlords that host the scores of leased locations that Rite-Aid intends to close as part of its restructuring strategy. This includes its planned sale of 78 Rite Aid and Bartell Drugs neighborhood pharmacy leases in free-standing buildings and retail shopping centers across nine states.

The challenges and uncertainty now faced by Rite-Aid’s lessors illustrate those regularly confronted by commercial landlords when a tenant’s bankruptcy or insolvency leaves them with unoccupied spaces and significantly diminished cash flow. As such, landlords must understand their options, rights, and remedies under the Bankruptcy Code to minimize the fallout and avoid inadvertent and costly mistakes when a tenant suddenly shutters its doors during a current lease term.

Assumption, Rejection, and Assignment of Lease Under Bankruptcy Code Section 365

Bankruptcy Code Section 365 governs the treatment of commercial leases in bankruptcy cases. Since the automatic stay, at least initially, limits the remedies and actions a landlord can take regarding the defaulting tenant, what happens next is largely up to the tenant. 

A tenant typically has 120 days after filing its bankruptcy petition to either reject, assume, or assume and assign or sell the lease.  

While a bankruptcy judge can extend the 120-day deadline for an additional 90 days for good cause without the lessor’s consent, the landlord’s assent is required for any further extension requests. 

During this period, the tenant must continue to satisfy its ongoing lease obligations, including paying rent, with post-petition rent obligations prioritized as an administrative claim. Notably, the lessor must continue to comply with the lease’s terms during this time or risk running afoul of the automatic stay.

If the debtor does not assume or reject its lease within the applicable time, the court will consider the lease rejected, and the tenant must then immediately vacate the leased premises.

Option 1: Rejecting the Lease

If a debtor elects to reject the lease, it essentially defaults and, accordingly, must vacate the premises. Upon rejection, the lessor can assert a “rejection damage” claim, which is considered a prepetition unsecured claim—sharing pro rata with other general unsecured creditors. Unlike other rejection damage claims, however, Bankruptcy Code Section 502(b)(6) caps the lessor’s rejection claims to the greater of one year’s rent or 15% of the rent of the remaining term of the lease, capped at no more than three years of total rent.

Option 2: Assuming the Lease

If the lessee opts to assume the lease, it essentially agrees to continue the lease, comply with its terms going forward, and cure any defaults. The lessee will identify the defaults to be cured and afford the lessor the opportunity to object to the proposed cure if it is insufficient. The debtor must also compensate the lessor for “any actual pecuniary loss” caused by the debtor’s default and provide the lessor with “adequate assurance of future performance.”

Option 3: Assuming and Assigning (or Selling) the Lease

Notwithstanding any anti-assignment language in the lease or any landlord objections, the debtor can elect to assume the lease and assign or sell it to a third party, as Rite Aid seeks to do with several leases. As with all lease assumptions, the tenant (and its assignee) must cure any outstanding defaults and provide adequate assurances of the assignee’s future performance of its lease obligations. 

Additional Protections and Assurances for Shopping Center Lessors

Many, if not most, of the leases Rite-Aid seeks to unload are in retail shopping centers. The Bankruptcy Code provides special protections for shopping center lessors when a debtor assumes and assigns its lease. 

Specifically, Section 365(b) requires debtors and assignees to provide the landlord with “adequate assurance” that: 

• The source of rent and other consideration due under the lease and the financial condition and operating performance of the proposed assignee and its guarantors, if any, will be similar to the financial condition and operating performance of the debtor and its guarantors, if any, as of the time the debtor started its tenancy.
• Any percentage of rent due under the lease will not decline substantially.
• Assumption or assignment of such lease is subject to all lease provisions, including those relating to radius, location, use, or exclusivity, and the assignment will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to the shopping center.
• Assumption or assignment of the lease will not disrupt any tenant mix or balance in such shopping center.

Failure to deliver any such assurances can support a lessor’s objection to any proposed assumption or assignment of the lease.

If you have concerns about your options as a landlord regarding an insolvent or bankrupt tenant or need assistance protecting your rights in a pending bankruptcy proceeding, please contact Anthony D’Artiglio at Ansell.Law.

Law, Not Lease, Defines Default

In a victory for landlords dealing with a tenant in bankruptcy, Ansell.Law attorney Anthony D’Artiglio recently secured a ruling in a reported decision that broadly defined the “defaults” tenants must cure in order to assume a lease. The decision in In re Old Market Group Holdings Corp. clarifies that a “default” as set forth in the Bankruptcy Code is given its ordinary meaning, regardless of any narrower definition of default contained in the lease.

The firm represented 400 Walnut Avenue, LLC (“Walnut”), which owned a product distribution center leased by the debtor, Fairway Group Holdings (“Fairway”), a regional grocery store chain. Fairway filed for Chapter 11 bankruptcy protection and sold most of its assets under the confirmed plan of reorganization. This included assigning its lease of Walnut’s property to another supermarket chain according to Section 365 of the Bankruptcy Code. Section 365 permits a debtor-lessee under an unexpired lease to assume (and subsequently assign) that lease if the debtor believes that assumption is in the estate’s best interest. If there is an existing default under the lease, Section 365(b)(1) requires that the debtor cure any such defaults as a prerequisite to assumption, among other obligations of the debtor.  

The dispute concerned Fairway’s responsibility, under Section 365(b), to cure defaults under its lease — specifically, its failure to make required repairs — when it assigned that lease. Fairway claimed that it had no obligation to make those repairs as its failure to do so was not a “default” as defined in the lease because Walnut allegedly did not demand that Fairway make those repairs before Fairway filed for Bankruptcy. As such, Fairway asserted that it could not be liable for the cost to make repairs to the property because no “default” — as defined by the Lease — occurred prior to Bankruptcy. 

“Any Failure To Perform” = Default 

In response, Walnut argued that any notice provision in the lease was irrelevant because a “default” under an assumed lease is given its ordinary meaning pursuant to Section 365, not the terms of the lease, and the outstanding repairs constituted a default as that term is plainly understood — a failure to perform a defined obligation. Accordingly, Fairway should be responsible for the cost of any repairs.

The bankruptcy court rejected Fairway’s position and agreed with the argument put forth by D’Artiglio on behalf of Walnut. The court ruled that: “Both the text and the purposes of [Section 365(b)(1)] compel the conclusion that the statutory term ‘default’ means any failure to perform under the assumed contract or lease, regardless of the definition of default contained in that contract or lease.”

The court went on to note that “Consideration of the purposes of Section 365(b)(1) reinforces the conclusion that the statutory term ‘default’ should be construed to include any failure to perform contractually required obligations.” Citing prior decisions, the court further stated that “The case law is consistent with this plain-meaning reading of the statute. When debtors seek to assume leases or contracts under which they have failed to make required repairs, courts routinely require the debtor to make those repairs — that is, to cure the defaults — as a condition to assumption.”

The interpretation of “default” articulated by the court applies to assumed executory contracts and assumed unexpired leases. The ruling Ansell’s lawyer obtained means that debtors will likely need to cure any failure, shortcoming, or unfulfilled obligation under a lease or contract — whether material or not, whether a “default” as defined in the agreement or not — before they can assume or assign such agreements. This further protects parties, including lessors, whose interests may be adversely affected by an uncured contract breach by a debtor.

If you have any questions about this case or its impact, please contact Anthony D’Artiglio.