Recent emergency motions from Modell’s Sporting Goods, Inc. (“Modell’s) and Pier 1 Imports, Inc. (“Pier 1”) to put their chapter 11 cases on ice may signal a growing trend. As the economic consequences of efforts to contain and respond to COVID-19 infections render deal-making difficult or impossible, what were the best-laid plans a few weeks ago often no longer make sense. Faced with nonessential business shutdowns, internal lockdowns by key players, and market volatility, debtors are turning to creative theories and little-used provisions of the Bankruptcy Code to preserve the value of their estates.
Modell’s Suspends Proceedings Under 11 U.S.C. § 305(a)
Modell’s and affiliates petitioned for chapter 11 relief on March 11, 2020, filing a first-day motion to approve procedures for liquidating 134 stores and an e-commerce site. Just twelve days later, the debtors filed an emergency motion to suspend all proceedings for sixty days, arguing that COVID-19 shutdown orders had prevented them from pursuing the sales and instead necessitated the suspension of operations and termination of most of their employees.
The motion relied on 11 U.S.C. § 305(a), which allows for the dismissal or suspension of a case if “the interests of creditors and the debtor would be better served.” It is most often used where state-court litigation may cause the bankruptcy case to be duplicative or unnecessary, or where a minority of belligerent creditors forces an involuntary bankruptcy to gain negotiating leverage. Modell’s proposed paying only critical expenses such as wages and insurance during the suspension period while deferring all other costs, maintaining the automatic stay, and adjourning all deadlines through twenty-one days past the period. Landlords objected, arguing that such relief would force them to subsidize the recovery of secured lenders. The court granted the motion but restricted the suspension to an initial thirty days, and it allowed parties to seek relief from the court during the suspension “with respect to exigent and unforeseen circumstances” that could not be consensually resolved.
Pier 1 Obtains Equitable Relief, Citing Contract Theories and Takings Doctrine
The bidding deadline for the auction of Pier 1 and affiliates had already passed when the debtors filed their emergency motion on March 31, arguing that shutting down their 461 stores in response to COVID-19 had squandered the opportunity for going-concern bids or a debt-for-equity swap and left them only with fee-based liquidation offers. Asserting that they would “not sit idly by and let the global pandemic control their fate,” they sought to pay only critical expenses during a “limited operation period” with monthly hearings to determine whether such period should be lifted, and they asked to automatically adjourn any motions relating to noncritical payments, stay relief, or the assumption or rejection of contracts through forty-five days after the period ends.
Rather than rely on § 305(a), the debtors appealed to the court’s equitable powers under § 105(a), arguing that shutdown orders constituted a government taking that triggered abatement clauses in their leases and that they were further excused from performance under the doctrines of impossibility and frustration of purpose. They also asked the court to enforce any non-lease contracts during the limited operation period and proposed procedures under which counterparties could seek administrative claims for the debtors’ breach. The court granted the motion on April 2, ordering that the debtors were relieved from paying rent to landlords who had not already agreed to a rent reduction as well as from making payments to certain vendors, shippers, and suppliers during the limited operation period. Similar to the Modell’s order, the court also set monthly hearings to address material disputes and determine whether a termination date for the period should be set.
Modell’s and Pier 1 will likely not be the only chapter 11 cases in which the economic fallout from COVID-19 temporarily renders the debtors’ strategy no longer economically viable, whether at the initial stages or with a sale process substantially underway. Because suspensions may allow debtors to preserve their value until the markets are functioning normally, bankruptcy stakeholders should be prepared to address such motions and consider strategies for protecting their interests in a fast-changing legal environment.
McGuireWoods has published additional thought leadership analyzing how companies across industries can address crucial business and legal issues related to COVID-19.