Revisions to Bankruptcy Code Sections 365 and 366

No longer will debtors and trustees be able to seek multiple extensions without a lessor's consent. The revision should reduce some of the uncertainty that landlords have faced under the prior version of ' 365(d)(4). Landlords will know that a lease will either be assumed or rejected within 7 months of the order for relief, unless they agree to a longer period of time.

This revision to ' 365 also recognizes that debtors who are lessees often need more than 60 days to make their assumption/rejection decisions. Unlike the prior version of the Code, such lessees will not need to make motions to extend the deadline within 60 days of the order for relief. They will have 2 additional months before needing to seek an extension. They will be able to get one 90-day extension over a lessor's objection. After that, the lease will be deemed rejected and the lessee will need to immediately surrender the property, unless the lessor agrees in writing to an additional extension.

In a related amendment, Congress capped the damages a landlord may seek when a lease is assumed by a debtor or trustee and later rejected. The landlord will be entitled to an administrative claim for all monetary obligations due for the 2 years following the later of the rejection or the turnover of the premises. 11 U.S.C. ' 503(b)(7). The landlord will have a claim for any remaining amounts due under the lease pursuant to ' 502(b)(6). Congress did not change ' 365(d)(3). Trustees and debtors will still be required to perform all obligations of a lease of nonresidential real property from and after the order for relief.

However, a change that Congress did make concerns a debtor's or trustee's obligations to cure a default when seeking to assume unexpired leases of real property. The new version of the Code provides that debtors and trustees will not have to cure nonmonetary obligations that would be impossible to cure at the time of assumption. 11 U.S.C. ' 365(b)(1)(A). However, with respect specifically to nonresidential real property leases, if the default arises from a debtor's “failure to operate in accordance” with the lease, then such default will need to be cured at and after the time of assumption. Moreover, a landlord will be entitled to compensation, as required by ' 365(b)(1)(B), for pecuniary losses resulting from such default.

Section 366

The new Code contains a significant addition to ' 366. It defines the “assurance of payment” that the providers of utility services are entitled to receive early in a Chapter 11 case. The “assurance of payment” may be any one of the following:

• A cash deposit;
• A letter of credit;
• A certificate of deposit;
• A surety bond;
• A prepayment of utility consumption; or
• Another form of security that is mutually agreed on between the utility and the debtor or trustee. 11 U.S.C. ' 366(c)(1)(A).

The prior version of the Code did not address whether a utility could receive an administrative expense priority as an assurance of payment. Courts, however, have often allowed debtors and trustees to utilize administrative expense priorities to satisfy their ' 366 obligations. No longer. The new Code makes clear that “an administrative expense priority shall not constitute an assurance of payment.” 11 U.S.C. '366(c)(B) (emphasis supplied). Instead, debtors and trustees must provide utilities with one of the forms of assurance set forth above.

These changes appear in a new section of ' 366 — section (c). Sections (a) and (b) remain substantively unchanged. Pursuant to section (a), a utility may not alter, refuse or discontinue service to, or discriminate against, the debtor or trustee solely on the basis of the commencement of a bankruptcy case or because a debt owed to a utility by a debtor was not paid when due. Pursuant to section (b), a utility may alter, refuse or discontinue service if neither the debtor not the trustee, within 20 days of the order for relief, furnishes adequate assurance of payment, in the form of a deposit or other security.

New section (c) will enable a utility, in a Chapter 11 case, to alter, refuse, or discontinue utility service, if during the 30-day period following the petition date the utility does not receive adequate assurance of payment — as described above — “that is satisfactory to the utility.” 11 U.S.C. ' 366(c)(2). This particular subsection of ' 366(c), which sets forth the 30-day period and includes the phrase “that is satisfactory to the utility,” will apply only to Chapter 11 cases, not Chapter 7 cases. Thus, in an involuntary Chapter 11, a utility would need to receive the assurance of payment within 30 days of the petition date, even if a court had not yet ordered relief and thereby triggered the 20-day period that debtors and trustees are afforded to provide assurance of payment pursuant to ' 366(b). (The new definition of “assurance of payment” is applicable to all bankruptcy cases, not just Chapter 11 cases.)

The phrase “satisfactory to the utility” would seem to give utilities an additional point to press in disputes that arise over the adequacy of a debtor's or trustee's form and amount of payment in Chapter 11 cases. No doubt, courts will be asked to decide if what a debtor or trustee proposes as assurance of payment is “satisfactory to the utility.” The statute will enable courts to modify the amount of an assurance of payment on a request of a party in interest and after notice and a hearing. 11 U.S.C. ' 366(c)(3)(A).

The new law also precludes courts from considering three specific factors when deciding if an assurance of payment is adequate:

• The absence of security before the petition date;
• The timely payment by a debtor of utility charges before the petition date; and
• The availability of an administrative expense priority. 11 U.S.C. ' 366(c)(3)(B). Rather, courts will need to determine if an assurance of payment satisfies any of the six forms of assurance now defined in Section (c)(1)(A).

The final provision of ' 366(c) provides a further benefit to utilities: Without notice or court order, utilities will be able to recover or setoff against a security deposit provided to them by the debtor before the commencement of a bankruptcy case. 11 U.S.C. ' 366(c)(4). Thus, although Code ' 362(a)(7) bars setoff absent notice and a court order, utilities holding a security deposit paid by the debtor prepetition will be allowed to setoff without having to give notice or receiving a court order.

The ultimate impact of ' 366(c) is that debtors will likely need more cash on hand to satisfy the “assurance of payment” requirement than would be needed under the prior version of the Code. A debtor's history of timely prepetition payments and the availability of an administrative expense priority will no longer be sufficient to constitute an “assurance of payment.” A debtor or trustee will need money on hand soon after filing to make cash deposits or prepayments for service, or to fund letters of credit, certificates of deposit or surety bonds.

Lessors of commercial property and providers of utility services should benefit from several key changes to the Code. Revisions to Sections 365 and 366 will provide lessors and utilities, respectively, with protections not found in the prior version of the Code.

Section 365

The revised Code includes several important changes related to the treatment of executory contracts and unexpired leases. Landlords of nonresidential real property should welcome the complete revision of ' 365(d)(4). That section will require a debtor that is a lessee to assume or reject a lease before the earlier of 120 days after the date of the order for relief or the date of entry of an order confirming a plan. A debtor, trustee or landlord may seek court approval to extend that time period for up to 90 days, for cause. Significantly, courts may grant a subsequent extension of the assumption/rejection deadline (beyond the first extension of 90 days) “only upon prior written consent of the lessor in each instance.” 11 U.S.C. ' 365(d)(4)(B)(ii). Absent such consent by the landlord, the debtor or trustee must decide to assume or reject the lease no later than 210 days after the date of the order for relief.

No longer will debtors and trustees be able to seek multiple extensions without a lessor's consent. The revision should reduce some of the uncertainty that landlords have faced under the prior version of ' 365(d)(4). Landlords will know that a lease will either be assumed or rejected within 7 months of the order for relief, unless they agree to a longer period of time.

This revision to ' 365 also recognizes that debtors who are lessees often need more than 60 days to make their assumption/rejection decisions. Unlike the prior version of the Code, such lessees will not need to make motions to extend the deadline within 60 days of the order for relief. They will have 2 additional months before needing to seek an extension. They will be able to get one 90-day extension over a lessor's objection. After that, the lease will be deemed rejected and the lessee will need to immediately surrender the property, unless the lessor agrees in writing to an additional extension.

In a related amendment, Congress capped the damages a landlord may seek when a lease is assumed by a debtor or trustee and later rejected. The landlord will be entitled to an administrative claim for all monetary obligations due for the 2 years following the later of the rejection or the turnover of the premises. 11 U.S.C. ' 503(b)(7). The landlord will have a claim for any remaining amounts due under the lease pursuant to ' 502(b)(6). Congress did not change ' 365(d)(3). Trustees and debtors will still be required to perform all obligations of a lease of nonresidential real property from and after the order for relief.

However, a change that Congress did make concerns a debtor's or trustee's obligations to cure a default when seeking to assume unexpired leases of real property. The new version of the Code provides that debtors and trustees will not have to cure nonmonetary obligations that would be impossible to cure at the time of assumption. 11 U.S.C. ' 365(b)(1)(A). However, with respect specifically to nonresidential real property leases, if the default arises from a debtor's “failure to operate in accordance” with the lease, then such default will need to be cured at and after the time of assumption. Moreover, a landlord will be entitled to compensation, as required by ' 365(b)(1)(B), for pecuniary losses resulting from such default.

Section 366

The new Code contains a significant addition to ' 366. It defines the “assurance of payment” that the providers of utility services are entitled to receive early in a Chapter 11 case. The “assurance of payment” may be any one of the following:

• A cash deposit;
• A letter of credit;
• A certificate of deposit;
• A surety bond;
• A prepayment of utility consumption; or
• Another form of security that is mutually agreed on between the utility and the debtor or trustee. 11 U.S.C. ' 366(c)(1)(A).

The prior version of the Code did not address whether a utility could receive an administrative expense priority as an assurance of payment. Courts, however, have often allowed debtors and trustees to utilize administrative expense priorities to satisfy their ' 366 obligations. No longer. The new Code makes clear that “an administrative expense priority shall not constitute an assurance of payment.” 11 U.S.C. '366(c)(B) (emphasis supplied). Instead, debtors and trustees must provide utilities with one of the forms of assurance set forth above.

These changes appear in a new section of ' 366 — section (c). Sections (a) and (b) remain substantively unchanged. Pursuant to section (a), a utility may not alter, refuse or discontinue service to, or discriminate against, the debtor or trustee solely on the basis of the commencement of a bankruptcy case or because a debt owed to a utility by a debtor was not paid when due. Pursuant to section (b), a utility may alter, refuse or discontinue service if neither the debtor not the trustee, within 20 days of the order for relief, furnishes adequate assurance of payment, in the form of a deposit or other security.

New section (c) will enable a utility, in a Chapter 11 case, to alter, refuse, or discontinue utility service, if during the 30-day period following the petition date the utility does not receive adequate assurance of payment — as described above — “that is satisfactory to the utility.” 11 U.S.C. ' 366(c)(2). This particular subsection of ' 366(c), which sets forth the 30-day period and includes the phrase “that is satisfactory to the utility,” will apply only to Chapter 11 cases, not Chapter 7 cases. Thus, in an involuntary Chapter 11, a utility would need to receive the assurance of payment within 30 days of the petition date, even if a court had not yet ordered relief and thereby triggered the 20-day period that debtors and trustees are afforded to provide assurance of payment pursuant to ' 366(b). (The new definition of “assurance of payment” is applicable to all bankruptcy cases, not just Chapter 11 cases.)

The phrase “satisfactory to the utility” would seem to give utilities an additional point to press in disputes that arise over the adequacy of a debtor's or trustee's form and amount of payment in Chapter 11 cases. No doubt, courts will be asked to decide if what a debtor or trustee proposes as assurance of payment is “satisfactory to the utility.” The statute will enable courts to modify the amount of an assurance of payment on a request of a party in interest and after notice and a hearing. 11 U.S.C. ' 366(c)(3)(A).

The new law also precludes courts from considering three specific factors when deciding if an assurance of payment is adequate:

• The absence of security before the petition date;
• The timely payment by a debtor of utility charges before the petition date; and
• The availability of an administrative expense priority. 11 U.S.C. ' 366(c)(3)(B). Rather, courts will need to determine if an assurance of payment satisfies any of the six forms of assurance now defined in Section (c)(1)(A).

The final provision of ' 366(c) provides a further benefit to utilities: Without notice or court order, utilities will be able to recover or setoff against a security deposit provided to them by the debtor before the commencement of a bankruptcy case. 11 U.S.C. ' 366(c)(4). Thus, although Code ' 362(a)(7) bars setoff absent notice and a court order, utilities holding a security deposit paid by the debtor prepetition will be allowed to setoff without having to give notice or receiving a court order.

The ultimate impact of ' 366(c) is that debtors will likely need more cash on hand to satisfy the “assurance of payment” requirement than would be needed under the prior version of the Code. A debtor's history of timely prepetition payments and the availability of an administrative expense priority will no longer be sufficient to constitute an “assurance of payment.” A debtor or trustee will need money on hand soon after filing to make cash deposits or prepayments for service, or to fund letters of credit, certificates of deposit or surety bonds.