A commercial tenant facing eviction may find relief under Chapter 11 of the Bankruptcy Code, particularly if the tenant fell behind on payments as the result of a temporary decline in income. While a Chapter 11 debtor cannot compel its landlord to reduce the monthly rent or eliminate past due rent, the filing of a Chapter 11 Petition will stop an eviction action and allow the debtor time to formulate a plan of action.

Absent abandonment or consent by the tenant, the landlord must file an eviction lawsuit in order to take possession of the business premises.[i] Once the landlord files a lawsuit to evict the commercial tenant, the tenant can stop the eviction action by filing of a Chapter 11 Reorganization.[ii] This allows the tenant time to remain in possession while it determines the best course of action. Bankruptcy Code Section 365 gives the tenant a deadline of 120 days to assume or reject the lease.[iii] The tenant may request that the bankruptcy court extend this deadline by 90 days, allowing up to 210 days for the tenant to assume or reject the lease.[iv]

Once the deadline arrives, in order to assume the lease and remain in the property, the tenant will need to provide a plan for promptly curing the pre-petition arrears.[v] The bankruptcy court’s interpretation of “prompt” cure will depend on the unique facts of each case, such as the remaining term of the lease.[vi] For instance, twelve months to cure arrears should be considered sufficiently “prompt” when the tenant has three years remaining on a five year lease. [vii] In contrast, curing pre-petition arrears over the remaining life of the lease will almost certainly be deemed inadequate by the bankruptcy court.[viii]

Should the tenant’s income prove insufficient to maintain the regular lease payment and cure the arrears within a reasonable period of time, Chapter 11 still offers the benefit of additional time to negotiate a reduced rent with the landlord. If the tenant cannot cure the arrears or reach an agreement with the landlord, the tenant must find an alternative location or close the business. If closure proves the only viable option, the tenant can file a Chapter 11 Plan of Liquidation or convert the case to a Chapter 7 in order to efficiently wind down the business and address any corporate liability for future rent or liquidated damages under the lease.

In summary, Chapter 11 may be a viable for a commercial tenant wishing to defend an eviction action and remain in possession of its business premises. For further information, contact an experienced professional to know your legal rights.

[i] Florida Statutes § 83.05.

[ii] 11 U.S.C. § 362(a).

[iii] 11 U.S.C. § 365(d)(4)(A).

[iv] 11 U.S.C. § 365(d)(4)(B).

[v] 11 U.S.C. § 365(b)(1)(A).

[vi] In re Embers 86^th Street, Inc., 184 B.R. 892, 900 (Bankr. S.D.N.Y. 1995).

[vii] In re Citrus Blvd Imaging Ctr., LLC, 2012 Bankr. LEXIS 2208, at *11-12 (Bankr. N.D. Ga. 2012).

[viii] In re Gold Standard at Penn, Inc., 75 B.R. 669, 673 (Bankr. E.D. Pa. 1987).

The goal of Chapter 11 generally is to restructure a Chapter 11 debtor’s monthly debt service and thereby improve cash flow to maintain a viable business. This can be accomplished by reducing principal owed, extending the length of a loan, and reducing the interest rate. The Chapter 11 Plan of Reorganization outlines these new terms that will form the basis for the new contractual rights between the debtor and creditors.

The debtor, a creditor, or another party in interest may file a Chapter 11 Plan. However, only the Debtor is permitted to file a Plan during the first 120 days after the Chapter 11 case is filed, or 180 days in a small business case.  After this exclusivity period expires, a creditor or party in interest may propose a Plan. Practically speaking a creditor rarely proposes a Plan, and therefore the Debtor is typically the “plan proponent”.

The Plan outlines the substantive rights of the debtor and creditors. In conjunction with the Plan, depending on the complexity of the case, the debtor must also prepare and file a Disclosure Statement to give more information to creditors regarding the debtor and the proposed Plan. After notice and a hearing the Bankruptcy Court determines whether or not to approve the Disclosure Statement as containing adequate information under 11 U.S.C. § 1125.

Once the court approves the Disclosure Statement, the Debtor provides the Plan and Disclosure Statement to each creditor in the case along with a ballot for voting to accept or reject the Plan. In order to successfully obtain confirmation of a Plan of Reorganization, Section 1129(a)(10) of the Bankruptcy Code requires that the plan proponent obtain the acceptance of at least one impaired class. This is assuming at least one class of claims under the Plan is impaired, which is virtually certain to be the case in most any Chapter 11 Plan.

Although one class in the Plan may contain multiple claims, typically, most classes in a Plan will contain the claim of a single creditor. Therefore, to meet this requirement outlined in Section 1129(a)(10) only one creditor must vote to accept the Plan in order to reach confirmation.  Although a Plan accepted by one creditor may technically meet the confirmation requirements, in practice a court may not confirm a Plan that merely meets the minimum requirements.

Where a class in the Plan contains only one creditor, calculating the acceptance or rejection of that class is straightforward. This will be the case for most secured claims, which are loans secured by collateral such as a house, car, building, equipment, or inventory. Unlike secured claims which are each placed in their own respective class, the class of general unsecured claims will contain many unsecured claims. Thus, the calculation of class acceptance or rejection may require a calculation consistent with 11 U.S.C. § 1126. This Code Section provides that a class has accepted the Plan if at least two-thirds (2/3) the dollar amount and greater than one-half (1/2) in number have accepted the Plan.

As an example, assume the Debtor owes four unsecured debts, Creditor A – $10,000, Creditor B – $15,000, and Creditor C – $25,000, and Creditor D – $50,000. If Creditor A & B accept and Creditor C & D reject the Plan, the unsecured class has rejected the Plan as only 1/2 the number of claims has accepted and the number must be greater than 1/2 the number of claims. If Creditor A, B, and C accept and Creditor D rejects then more than 1/2 the number has accepted, but less than 2/3 the dollar amount has rejected and therefore the unsecured class has rejected.

If Creditor A, B, and D accepts and Creditor C rejects then the conjunctive requirements for class acceptance have been met, 3/4 of the dollar amount has accepted and 3/4 of the number of claims has accepted, and therefore the unsecured class has accepted. As a final illustration, if three of the creditors were to abstain from voting, and Creditor A were to accept, the unsecured class would therefore accept the Plan under Section 1126 as only those claims that accept or reject are counted when calculating the class acceptance or rejection. Even though Creditor A held the small claim of $10,000, since the other creditors failed to vote, this creditor dictates the outcome of the voting.

This voting process is only one of the many aspects of a Chapter 11 case. At Mickler & Mickler, we deal with these issues in Chapter 11 cases on a daily basis. We hold the knowledge to guide an individual or business through this complicated process. Contact us at 904.725.0822 or tjking@planlaw.com should you need counsel regarding your financial situation. The consultation is free.

The absolute-priority rule was a judicial invention intended to prevent equityholders and secured creditors from colluding to the detriment of unsecured creditors.[1] The Bankruptcy Reform Act of 1978 codified the absolute-priority rule at 11 U.S.C. § 1129(b)(2)(B)(ii), which requires for dissenting unsecured creditors to be paid in full before equityholders may retain property under a reorganization plan.

The absolute-priority rule is “generally applied to for-profit corporations facing bankruptcy, where an equityowner seeks to retain property, often represented by stock.”[2] The applicability of the absolute-priority rule to a nonprofit debtor presents an uncommon question. The only two circuit courts of Appeal to decide the issue have found the absolute-priority rule does not apply to nonprofit debtors.

Seventh Circuit: Absolute-Priority Rule Does Not Apply to a Nonprofit Electric Utility     The Seventh Circuit analyzed the absolute-priority rule in the context of an electric utility cooperative.[3] The Seventh Circuit ruled that members (equityholders) of a nonprofit debtor did not hold “interests” in the debtor and therefore the debtor’s reorganization plan did not violate the absolute-priority rule. The dissenting unsecured creditor in Wabash objected on the grounds that the member cooperatives retained control of the reorganized debtor and received some economic benefit from the reorganized debtor. The Seventh Circuit found the “member cooperatives…do not improperly retain property ‘on account of’ either their patronage capital accounts (which are mere refunds of overpayments) or their control over [the Debtor].”[4] Identifying three indicia of ownership (control, profit share and ownership of corporate assets), the Wabash court determined that retention of managerial control was insufficient to trigger the absolute-priority rule in the context of an electric utility.

In concluding that the member cooperatives did not retain an interest in the reorganized debtor, the Seventh Circuit relied on Indiana state law as it pertains to nonprofits in general as well as regulation on Indiana utility companies. Generally, Indiana law prohibits nonprofit companies from paying dividends to its members and provides that, upon dissolution, any equity in assets escheats to the state.[5] As to utility regulations, the Seventh Circuit found it important that Indiana law prohibited the debtor from charging customers more than the cost of electricity provided.[6]

Thus, the Seventh Circuit’s decision is limited to some extent as the debtor was an electric utility. However, the decision still may generally apply to any nonprofit chapter 11 debtor. Provisions similar to the Indiana statutes noted in Wabash may exist in the law of one’s jurisdiction. For example, under Florida law, nonprofit corporations are prohibited from making distributions to its members, subject to limited exceptions.[7]

Ninth Circuit Expands on the Wabash Decision     Ninth Circuit relied on Wabash in ruling that an international labor union was not an owner of its local branches for purposes of the absolute-priority rule.[8] In the Teamsters case and unlike the circumstances in Wabash, the debtor held a contingent future interest in the assets of any dissolved local union. The Ninth Circuit found this insufficient to establish ownership without any other indicia of ownership. The Ninth Circuit noted the rationale behind the absolute-priority rule as it pertains to for-profit chapter 11 debtors. The concern of an equityholder is purely an economic one, focused on the profitability of the corporation.

Other courts have applied slightly different rationale in reaching the same conclusion as the Seventh and Ninth Circuits.Rather than focusing on the interest retained by equityholders, the court in In re Save Our Springs Alliance Inc.[9] found that a nonprofit corporation simply has no equityholders. The debtor in that case existed to promote water conservation in west Texas. The court did not find it necessary to examine the indicia of ownership or other factors, but cited the circuit court decisions that the proposition that the equityholders did not retain an interest in the reorganized debtor.

Conclusion     The applicability of these decisions to other types of nonprofit organization will largely hinge on the stated purpose of a given debtor and the existence of monetary incentives for the equity holders provided in a proposed plan of reorganization. As explained by the Ninth Circuit, the absolute-priority rule exists to prevent abuse by debtors with solely pecuniary motivation, which is the motivation of most business ventures. The same rationale behind the absolute-priority rule fails where the debtor exists to serve a community function, such as in the context of a labor union, electric cooperative, historical society, environmental protection group or religious organization.

1. See In re Wabash Valley Power Ass’n, 72 F.3d 1305, 1314 (7th Cir. 1996).