The impact of COVID-19 is being felt at all levels of the economy and will work its way through bankruptcy courts for years to come. In these early days, many creditors who are themselves suffering are providing assistance to troubled companies. Suppliers and commercial landlords are agreeing to various forms of relief, including modified credit terms and rent relief to allow customers to bridge this period of unprecedented disruption. While these corporate good Samaritans are providing immediate aid they may be subjecting themselves to the risk of future losses.
Consider the supplier extending terms now to a customer who inevitably files for bankruptcy. As creditors to troubled businesses know, payments received from a debtor within 90 days of bankruptcy are subject to potential avoidance as a preference. One of the primary preference defenses is the “ordinary course” defense, which insulates payments received in the ordinary course of business with the debtor. The defense can be weakened if the payments at issue are made later than historic averages or eliminated if the payments are made by special arrangement. As a result, under current law, the supplier who works with its customer and modifies payment terms to help them confront the economic fallout of COVID-19 may suffer increased future exposure because one of the most common statutory preference defenses is harder to prove.
The risk to landlords is similar as courts have held that (i) an agreement to forbear from eviction does not insulate back rent payments from avoidance, and (ii) deferred rent payments are avoidable because payments made pursuant to unique agreements are not in the ordinary course of business.
Lenders that agree to loan amendments and forbearances to address COVID-19 will face similar concerns. What of the lender that agrees to amend a financing agreement, extending maturity or offering interest-only terms during the crisis, and takes a lien on additional collateral as protection against the increased risk? If the borrower ultimately files for bankruptcy, the lien on new collateral may be subject to preference attack.
Absent fraud or other misconduct, should such creditors be penalized for working to find solutions during times of crisis? Congress could make clear that, absent fraud or misconduct, creditor concessions granted during the COVID-19 crisis are presumptively immune from avoidance under the Bankruptcy Code. This would protect parties that proactively step in to help, and might encourage others to do the same.