Many retail bankruptcy cases are filed under Chapter 11 of the Bankruptcy Code, but some convert to Chapter 7 cases or, less likely, are filed that way at the outset. Retail landlords should be aware of the major differences so they are better prepared when their tenant commences a bankruptcy case.
Chapter 11 Retail Bankruptcy Cases
Chapter 11 cases—as discussed in Bankruptcy Basics Issue 4—can be reorganizations, going concern sales, liquidations, or a combination of going concern sales and liquidations. While a trustee can be appointed for “cause,” typically the debtor remains in control of its assets and operates its business as a debtor-in-possession. Alternatively, the bankruptcy court could appoint an examiner to investigate the debtor as appropriate.
Generally, the debtor will work toward filing a Chapter 11 plan and disclosure statement for the plan. The disclosure statement must provide sufficient information that would enable a hypothetical investor (e.g., claim holders) to make an informed judgment about the plan. If the disclosure statement is approved, a hearing on the plan is scheduled. Leases that have not been assumed or rejected can be assumed or rejected under a plan. Creditors are placed in different classes in a plan depending on the nature of their claims, and those creditors deemed “impaired” are entitled to vote on the plan.
A plan typically includes conditions to its effectiveness, such as a debtor obtaining exit financing. Once those conditions are met and the plan becomes effective, the debtor emerges from bankruptcy and can conduct its business with minimal bankruptcy court oversight, even though the case remains open.
Unless a plan of reorganization is confirmed, the case will either be (a) dismissed, including by way of a structured dismissal—the theory being that some value (or more value) could be distributed to creditors instead of incurring the costs of confirming a plan; or (b) converted to a Chapter 7 bankruptcy case.
Chapter 7 Retail Bankruptcy Cases
Chapter 7 bankruptcy cases are liquidations in which a trustee is appointed to manage and liquidate the debtor’s assets for the benefit of creditors. Tenants who file bankruptcy petitions under Chapter 7 are not authorized to operate their businesses. Trustees can seek bankruptcy court authority to operate the business, but this is rare; if a tenant in Chapter 7 is continuing to operate, you should alert the Chapter 7 trustee.
It is possible, but highly unlikely, that a Chapter 7 trustee would market a debtor’s unexpired leases for assignment to third parties. Chapter 7 cases generally do not have liquid assets to pay post-petition rent, and the trustee will not want to create administrative priority claims that will need to be paid before claims of general unsecured creditors. For these reasons, trustees often seek to reject leases very early in Chapter 7 cases.
The trustee will file a final report once the liquidation of bankruptcy estate property has concluded. The final report will indicate how the trustee proposes to distribute available cash to creditors on account of their claims. It’s important to carefully review the final report to make sure cash is to be distributed to creditors in their order of priority established by the Bankruptcy Code. Creditors can object to approval of the final report. Most Chapter 7 cases terminate as “no asset” cases in which no value is distributed to unsecured creditors.
In both Chapter 11 and Chapter 7 retail bankruptcy cases, landlords should closely track the treatment of real property leases. Issue 6 of Bankruptcy Basics for Retail Landlords will cover the debtor or trustee’s options: assumption, assumption and assignment, or rejection.