How a temporary bankruptcy law change made rent deferral less risky for landlords

On Dec. 27, President Donald Trump signed into law a temporary change to Bankruptcy Code that mitigated certain risks for commercial real estate landlords working with tenants on rent deferral. Part of the behemoth year-end COVID-19 relief bill, the measure means that coming installment payments for back rent won’t be clawed back if a tenant files for Chapter 11 bankruptcy protection.

When the U.S. economy seized up following widespread lockdowns in spring 2020, owners of commercial real estate faced a sudden drop in rent payments from tenants. This situation only worsened as the months passed, at times putting owners in a precarious financial condition. In late 2020, the Financial Times stated that “mall owners are facing a financial reckoning as retailers from Urban Outfitters to Calvin Klein stop paying rent in the coronavirus shutdown.” And in December, Bloomberg reported that the hospitality and retail sectors had been flashing warning signals throughout the year and that the “most glaring distress is in the $529 billion market for bonds backed by commercial real estate loans. … The delinquency rate last month for commercial mortgage-backed securities was 20 percent for hotels and 14 percent for retail.”

Early in the pandemic, many landlords began to negotiate rent deferrals with tenants that could not or would not pay rent. These deferrals often involved agreements to allow tenants to forgo rent for some period if the back rent could be repaid in installments as the tenants’ financial conditions improved. Unfortunately, the possibility that tenants, especially retail businesses, would later file for bankruptcy protection presented its own, prohibitive challenge. Under bankruptcy law, these back rent installments likely would be deemed preferential payments and landlords would be forced to return the funds to the bankruptcy court. The notion of “preferences” in bankruptcy is designed to prevent cash-strapped businesses from paying preferred creditors ahead of others. This otherwise laudable policy goal threatened to thwart creative solutions to the economic challenges of COVID-inspired lockdowns.

Congress recognized this problem quickly, and throughout 2020, there were quiet discussions between industry leaders and policymakers in Congress to address the bankruptcy risk of rent deferrals. In August, Sen. Thom Tillis (R-NC) introduced legislation on the issue. Eventually, it made it into the $2.3 trillion relief bill Trump signed just before the turn of the year. It provided that, for rent deferrals entered into between March 13, 2020, and Dec. 27, 2020, payment of past-due amounts owed cannot be considered preferences. The law also provides small businesses that are in Chapter 11 with greater flexibility and allows commercial tenants more time to start making rent payments after they file for bankruptcy.

These seemingly technical changes were a win-win. Commercial landlords could negotiate for future payment of rent, and commercial tenants could preserve scarce cash until the U.S. economy reopened. Significantly, the law does not involve the use of any federal funds. Instead, it facilitates private sector, consensual solutions.

Only time will tell how these changes will affect commercial landlords and tenants. Anecdotally, ICSC has received reports from members and from attorneys representing landlords that owners are more confident providing rent deferrals. At a minimum, policymakers should monitor the effects of these changes to determine whether they might need to be extended should the U.S. economy falter as the COVID pandemic continues to present challenges to U.S. businesses.