It has been just over a year since the first known COVID-19 cases and related shutdowns occurred in the US. In early 2020, everything from grocery shopping to global politics was deemed “unprecedented” and “unpredictable.” However, as the pandemic continues into 2021, precedents have begun to be established, even as unpredictability remains. In the field of bankruptcy, as elsewhere, we are seeing new trends and establishing new ways of practicing, some of which look likely to survive the pandemic, even if many businesses do not.
The Virtual Pivot
Government restrictions and public health concerns abruptly forced restructuring practitioners to a virtual platform in March 2020. Court offices were closed, physical document deliveries were prohibited, physical client meetings became a public health risk, and courts mandated that hearings be held telephonically or by video conference. While some of these restrictions have eased, most practitioners are still working virtually, either due to continuing restrictions, or simply because it is a more efficient system.
In Delaware, since March 2020, the use of telephonic hearing or video conference has been at the discretion of the presiding judge determined on a case by case basis. Indeed, we participated in the first hearing before Delaware’s Bankruptcy Court to be handled entirely remotely, and little did we know how things would be almost one year later. Telephonic hearings seem to be the preference of most judges, with many adding individual requirements, such as pre-hearing identification of witnesses to ensure a smoother hearing. In our experience, the bankruptcy courts are running smoothly and it has been business as usual. Indeed, an argument could be made that cases are more efficient for a number of reasons, including that the bankruptcy estate does not incur the additional expenses associated with travel and lodging of professionals and management.
Additionally, behind the scenes things are different as well and often more efficient. The Office of the United States Trustee, for example, who is charged with forming an official committee of unsecured creditors in Chapter 11 cases, the processes of information gathering and creditor selection for the formation meetings are also functioning entirely remotely. The long-settled routine of standing around a conference room in the Courthouse or local hotel waiting for interviews and formation announcements is gone and few practitioners likely eager to see its return.
Telephonic and video conferences are also being used for attorney/client meetings, negotiations, and official arbitrations. Documents are being prepared, shared, signed, and delivered electronically. Many attorneys are conducting a busy bankruptcy practice without ever leaving their home office, and clients are ultimately benefiting from the efficiencies of less travel, less down time, and reduced legal fees and expenses. There is hope that these efficiencies may also help to ease the congestion that is expected in the bankruptcy courts in 2021 – the number of bankruptcy practitioners are likely not increasing to meet the demand in coming months, suggesting that restructuring professionals across the board should be busy
Survival in an Uncertain World
The unpredictability of the current economic environment continues to cause havoc for businesses across a wide array of industries and has affected the use of bankruptcy as means of survival. Chapter 11 bankruptcy is designed to help struggling companies restructure and survive. In the current environment of travel restrictions, shipping delays, supply chain difficulties and shutdowns, it is difficult for a debtor to create a viable restructuring plan of reorganization or through a sale of its assets in bankruptcy. However, it is practically difficult to present a viable restructuring strategy for a business that depends on its client or customer basis also facing continued uncertainty in the coming months absent some predictions relating to the success of vaccines or other means to move us closer back to “normal” life. Many struggling companies are trying to avoid bankruptcy by increasing or extending borrowing to stay afloat until relief arrives in the form of government assistance such as PPP loans, a cash infusion from investors, or a return to a “normal” business income stream. Unfortunately, the longer the pandemic continues, the more companies will exhaust this temporary relief and fall into bankruptcy. Analysts expect a surge of such bankruptcies in 2021.
The increasing corporate reliance on debt has been exacerbated by market interventions from the Federal Reserve to reduce the cost of corporate borrowing. This in turn has led to a rising number of “zombie” companies that do not have sufficient operating income to cover their annual debt costs. JC Penney, which declared bankruptcy in May 2020, and AMC Theatres (and now the recent subject of day trading seeking to drive up the price through crowd-funding volume to the chagrin of short sellers, discussed a bit below), which has been valiantly avoiding bankruptcy, are two prominent examples. Critics argue that government interventions to reduce the cost of borrowing may be helping companies to avoid bankruptcy in the short term but are only masking a problem that could lead to a surge in bankruptcies and a difficult economic recovery in the long term.
There have also been some surprise stock market moves by companies and investors to prop up struggling companies. Despite declaring Chapter 11 bankruptcy in May 2020, Hertz tried a month later to make a $500 million share offering that Hertz itself warned could be “worthless.” The decision was approved by a Delaware Bankruptcy Judge Mary F. Walrath before being pulled by Hertz when the SEC moved to review it. Other companies have had differing results outside of bankruptcy. GameStop and AMC Theatres, both struggling companies on the brink of bankruptcy, made headlines recently when retail investors bought up huge amounts of stock in an attempt to squeeze short sellers, driving up the stock prices by 1700% and 840%, respectively. AMC Theatres has since announced that bankruptcy is “off the table” due to cash infusion from a December stock offering and a new line of credit, that it hopes to carry it through 2021 and the pandemic. GameStop, however, may be buoyed by the huge market value increase, but analysts still question the underlying value of the company, which was declining pre-pandemic, and whether it can ultimately avoid bankruptcy.
Setting Precedents in Unpredictable Times
We are seeing some patterns start to emerge in post-COVID bankruptcies and it will be interesting whether those patterns continue. Bankruptcy courts and practitioners have always been nimble are willing to think constructively to provide extraordinary relief to meet these extraordinary times. Chapter 11 retailers, such as Modell’s Sporting Goods and Pier One Imports, who usually look to going-out-of-business sales and shuttering locations to improve liquidity, have been granted extraordinary equitable relief in “mothball” motions under 11 U.S.C. § 305(a) and 105(a). These provisions, rarely used pre-COVID, were used to suspend or avoid rent payments and prioritize the payment of expenses which the company could deem critical, such as wages and e-commerce expenses for an extended period of time. This is intended to give the debtor some breathing space and is less likely to be granted if it only delays the inevitable such as Art Van Furniture, which in major financial difficulties before the pandemic and failed to convince a Delaware court that granting its mothballing motion would be beneficial whose interest holders are now again seeing continued struggles through the more recently filed Love’s Furniture bankruptcy. It remains to be seen how this balancing act by the courts will be affected by changing economic conditions.
Furthermore, the combination of government moratoria on evictions and the courts’ approach to protecting debtors against eviction has had the effect of imposing a disproportionate economic burden on landlords in the pandemic. This has further led to an increase in rent abatements, reductions and workouts as landlords and tenants both strive to survive these uncertain times which is further stressing those affected industries. Landlords are not the only creditor group impacted. We are also seeing a more limited returns to creditors as debtors’ options to restructure or create liquidity are limited by the severe reduction or complete shuttering of businesses. Some industries understandably have been hit particularly hard. The travel, retail, leisure and hospitality industry has few options when travel locally and worldwide is restricted. Mandated shutdowns and supply chain difficulties further limit a retail sector that was already struggling to pivot to e-commerce. Debtors simply may have limited means to generate liquidity to pay creditors.
The stress on liquidity is further pronounced when juggling the expense associated with filing chapter 11 protection. Companies that have declared bankruptcy in 2020 tend to have exited bankruptcy relatively quickly when possible, presumably in an attempt to minimize administrative expenses and avoid the inevitable next wave of pandemic bankruptcies. For example, 24 Hour Fitness filed for bankruptcy in June 2020 and emerged from Chapter 11 restructuring on December 21, 2020. Ruby Tuesday filed for bankruptcy in October 2020 and received court approval in Delaware of its sale of business plan less than two months later, however, it did then fail to find a buyer and has also shifted to a lender takeover strategy through a plan. This faster and more efficient process may be beneficial to all if bankruptcy courts get the surge of bankruptcies that are widely expected in 2021.
The COVID-19 pandemic has affected how attorneys, the Courts, and stakeholders approach bankruptcy. More than ever, the resolve of practitioners and the Courts continues to be innovative and flexible to meet the demands of these uncertain times as we prepare for the year ahead.