US Bankruptcy Courts Offer Extraordinary Relief Amid COVID-19

In response to the coronavirus (COVID-19) pandemic, US bankruptcy courts have granted extraordinary equitable relief in some cases. As government orders enforcing stay-at-home measures have forced many businesses to shutter indefinitely, bankruptcy courts have implemented procedures to allow the ongoing—albeit virtual—administration of bankruptcy cases.

A Roll of the Dice: Mothballing Bankruptcy Cases Under 11 USC § 305(a)

COVID-19 had an immediate impact on businesses across the country, especially those retailers and suppliers whose “nonessential” businesses were subject to mandated closure. Some borrowers were already in financial distress and had filed for relief under Chapter 11 before the pandemic. Indeed, the severity of COVID-19 prompted certain debtors to request a temporary suspension of all proceedings in their bankruptcy cases pursuant to the courts' equitable powers under 11 USC § 305(a).

Courts have granted these “mothball” motions in the cases of retailers and restaurateurs like Pier 1 Imports, Modell’s Sporting Goods, and CraftWorks. These debtors persuaded the courts that suspending proceedings might provide the breathing room they needed to preserve their restructuring or orderly liquidation plans.

On March 27, 2020, the US Bankruptcy Court for the District of New Jersey suspended the Chapter 11 cases of Modell’s and its affiliates for 60 days.[1] Modell’s was generating revenue through closeout sales to conduct an orderly liquidation when government orders forced store closures and shut off all revenue streams. Modell’s suddenly lacked the cash to pay landlords while liquidating; it let go nearly all of its employees, including retail and distribution staff, and sought and was granted emergency relief under Section 305(a).

The Delaware and Virginia bankruptcy courts entered similar orders in the following days. Brewpub chain CraftWorks Parent LLC and its affiliates obtained a mothball order from the Delaware Bankruptcy Court on March 30, and Pier 1 Imports Inc. and its affiliates were granted similar relief over the objection of landlords and other creditors on April 2.[2]

Mothballing provides a pause—another roll of the dice with the hope that viral disruption is sufficiently short-lived to restore enough liquidity to benefit all parties in the future. As the pandemic timeline extends, it is unclear whether suspension will ultimately prove a useful bridge until revenues return for the benefit of all parties in interest—or merely a futile delay of liquidation that further diminishes creditor recoveries.

On April 20, 10 days before its suspension elapsed, Modell’s filed notice of its intent to seek a one-month extension and was scheduled a hearing on April 30.[3] Pier 1 Imports filed a similar motion to extend its “limited operations period.” As other debtors, and their landlords and creditors, watched closely—both courts granted these unprecedented requests for a “creeping” Section 305(a) suspension until May 31 over the objection of the landlords and creditors. Pier 1 Imports may seek yet another extension; a hearing is scheduled for May 29.

The odds of rolling the dice do not always favor mothballing, and not all debtors have avoided liquidation (or orderly liquidation) through case suspension under Section 305(a). For example, Art Van Furniture and VIP Cinema were implementing restructurings under Chapter 11 in Delaware when COVID-19 struck. After filing for bankruptcy in the District of Delaware only days before the COVID-19 fallout, Art Van Furniture sought a mothballing strategy to weather the coronavirus closures that thwarted its restructuring plans. Nonetheless, Art Van failed to demonstrate to its stakeholders how a respite could benefit the already struggling retailer—and ultimately converted the cases to Chapter 7 on April 6, 2020.[4]

VIP Cinema, a manufacturer of reclining seats for movie theaters, sought relief in Delaware under Chapter 11 in February 2020 when it filed a consensual prepackaged plan to strip $150 million of debt from its balance sheet. Enter COVID-19 and the ensuing shutdown of nonessential services, including movie theaters. VIP’s market evaporated overnight—as did the feasibility of its prepack. VIP’s CEO resigned, plan supporters withdrew, and VIP pivoted from reorganization to orderly liquidation.[5]

Bankruptcy courts have limited tools to protect insolvent or struggling debtors from the additional economic impact of a pandemic. Section 305(a) is an extraordinary measure that provides a little more time—but a two-month reprieve may not be enough. The relief is a suspension; it provides no discharge of post-petition obligations incurred by the debtors. Therefore, even debtors obtaining “mothball” relief under Section 305(a) may be no better off if they are unable to reopen retail locations in time to generate the revenues required to pay landlords for catchup payments due at the expiry of suspension—whether limited to 60 days or extended further, if permitted.

Bankruptcy Courts Continue to Operate Electronically and Provide Administrative Relief

As described in an INSOL International article authored by Morgan Lewis lawyers, US bankruptcy courts continue to operate in a virtual environment, offering unparalleled reliability during the pandemic: “Given the national reach of the United States bankruptcy system, courts readily accommodated remote appearances and electronic filings before the pandemic, making them well equipped to transition quickly to implement additional tools and strategies to ensure continued, though remote, judicial access.”

While bankruptcy courts cannot undo the macroeconomic impact of COVID-19, the courts are implementing measures to facilitate the administration of bankruptcy cases by using electronic means to conduct hearings and meetings, submit evidence, examine witnesses, and generally administer cases. Such measures include the following.

Postponing Nonurgent Hearings, Status Conferences, and Trials (Delaware, SD Texas, SD Florida and Others)

To help stop the spread of COVID-19, and to conduct a triage of their limited resources, some federal courts, including bankruptcy courts, temporarily stayed nonessential trials, hearings, and conferences. A federal court in Florida entered an order to extend discovery deadlines notwithstanding objections. It cited “the present difficulties of working remotely with limited staff and resources against the COVID-19 backdrop,” and recognized that it was appropriate in that case to extend deadlines given that “a national emergency has been declared by President Trump, the State of New York has been particularly crippled by the outbreak, and courts and other workforces across the nation are stretched thin.”[6] Procedures for postponement in some districts, like the Eastern District of New York, are judge-specific and courts that initially entered automatic postponement orders are revoking or amending them as the economy reopens.

Note that not all courts have permitted delays, especially where the court views a party as using the pandemic as a pretext for continued inaction. For instance, a debtor in the Southern District of New York had appealed a decision of the bankruptcy court to the district court nearly a year ago but cited COVID-19 difficulties in seeking an extension to prosecute the appeal. Although the district court acknowledged it had granted every other COVID-based request for an extension or teleconference, it condemned the debtor’s attempt to justify its “lengthy, repeated and [nearly yearlong]” failures on COVID.[7]

Tolling All Court-Imposed Deadlines (SD Texas)

The US Bankruptcy Court for the Southern District of Texas entered a general order that tolled all court-imposed deadlines imposed by the Federal Rules of Bankruptcy Procedure and/or the local rules by the number of days that the court’s COVID-19 protocols are in place. The tolling period provision of the order terminated May 4, 2020, after being in effect for 41 days in the Houston Division.

Conducting Hearings Telephonically and by Videoconference, and Creating Protocols for Submitting Evidence (Delaware, SDNY, SD Texas, EDNY, CD California, MD Florida, SD Florida)

Many bankruptcy courts were already proficient in conducting telephonic hearings or allowing optional telephonic appearances for in-person hearings. In response to the pandemic, such courts have expanded virtual offerings and now (temporarily) require telephonic and/or video appearances.

Where parties must submit evidence, some courts have also either established protocols or announced that judges will create protocols with the parties on an ad hoc basis. For example, some courts require parties to submit evidence in advance of trial by electronic filing via ECF.

Establishing Protocols for Examining Witnesses by Videoconference (SD Texas and Others)

While protocols may vary by jurisdiction, the Southern District of Texas has long used relatively advanced telecommunications protocols in hearings, and has now established (temporary) procedures requiring witnesses to appear by audio and video connection (including the use of a phone or other video device) via the Join.me website, allowing the court to administer the oath over audio connection, and allowing parties in interest to present documents in connection with examination via the Join.me website.

Recording Telephonic Hearings, Conferences, and Trials (e.g., Through Court Solutions) (SDNY, SD Texas, and Others)

In order to create and maintain official records of proceedings during the pandemic, some bankruptcy courts are allowing court personnel to make recordings using the applicable teleconference technology—and making such recordings part of the official record.

Conducting Section 341 Meetings by Telephone or Videoconference (SDNY, SD Texas, MD Florida, SD Florida and Others)

The United States trustee appointed in a bankruptcy case presides over a Section 341 meeting during which the trustee and creditors may question the debtor under oath regarding its assets, liabilities, and other matters pertaining to the case. These meetings are held outside of court (and without a judge present) in conference rooms selected by the trustee. As with in-court hearings, bankruptcy courts are allowing the use of secure technology to facilitate compliance with Section 341 while avoiding transmission of the virus through in-person meetings.

Suspending the Requirement to Obtain/Maintain Original Signatures (SDNY, SD Texas, CD California, MD Florida, SD Florida, and Others)

Whereas bankruptcy courts require wet signatures for certain documents, particularly for certain debtor filings, some courts are now permitting the use of electronic signatures for such filings and expanding the scope of permitted electronic signing technology (such as DocuSign) that maintains an audit trail. Such technology allows the filing attorney to obtain the identification of the signer’s computer or device from the commercial provider and otherwise complies with the requirements of the US ESIGN Act.

Allowing Judges Other Than the Judge Assigned to a Case to Preside Over Hearings (SD Texas)

To further promote judicial efficiency and effective triage of bankruptcy matters during the COVID-19 pandemic, some bankruptcy jurisdictions are allowing “judge swapping” as may be needed for the administration of the case, notwithstanding case assignments.

Bankruptcy courts and the Bankruptcy Code already provide a means for debtors and creditors to effectively pursue in-court reorganization or liquidation. However, in light of the added burden of the COVID-19 pandemic on distressed businesses and debtors, bankruptcy courts continue to implement the tools available to them to improve the process and offer relief as may be justified—without Congress, to date, amending the Bankruptcy Code to provide additional relief for large businesses in bankruptcy.

Requiring Masks or Face Coverings in Court (Delaware)

To prevent the spread of COVID-19, visitors to bankruptcy courts in some jurisdictions are required to wear masks or face coverings when interacting with court staff and in the common or public areas. These requirements mirror various state and local executive orders.

Coronavirus COVID-19 Task Force

For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Marjorie S. Crider
Matthew F. Furlong
Sula R. Fiszman
Andrew J. Gallo
Edwin E. Smith
Sandra J. Vrejan

New York
Kristen V. Campana
Jennifer Feldsher
Glenn E. Siegel
Craig A. Wolfe
Jason R. Alderson

Philadelphia
John C. Goodchild, III