What Is Bankruptcy Mothballing?

What can a company already in bankruptcy do when a government shutdown order closes its stores in the middle of the case? During the COVID-19 crisis, some debtors asked bankruptcy courts for a time out.

Joel Cohen talks with Rachel Albanese, now partner and co-chair of the Restructuring Group at Debevoise & Plimpton and a partner at DLA Piper at the time of this conversation, about the practice sometimes called mothballing: what it is, where the legal authority comes from, who bears the cost, and whether it will last.

A Time Out in Chapter 11

Albanese explains that 2020 brought an unprecedented number of bankruptcy filings across industries, including oil and gas, health care, restaurants, and especially retail, where mothballing emerged. Ordinarily, a Chapter 11 debtor must pay all of its operating expenses after the filing, in what is called the post-petition period. A debtor seeking mothballing relief asks the court to put its case into suspension. The pause is not indefinite. Courts have granted relief for periods such as 30, 60, or 90 days, and debtors can ask to extend it for a limited time when the initial period ends.

The Legal Basis

Bankruptcy courts are courts of equity, Albanese explains, and two provisions of the Bankruptcy Code support this relief. Section 105(a) is a broad grant of equitable discretion, and section 305(a) allows a court to suspend or dismiss a case, including when the interests of creditors and the debtor would be better served. That suspension power gives mothballing its name. Courts generally apply a totality-of-the-circumstances test, and during the pandemic they granted relief because of reduced foot traffic and uncertain outcomes, particularly in retail.

One of the earliest examples was the Modell's Sporting Goods case, where the retailer was about to hold liquidation sales when shutdown orders closed its stores. Mothballing orders followed in cases including Pier 1, CraftWorks, and JCPenney, and Brooks Brothers sought effectively the same relief: a period in which the debtor did not have to pay rent.

Landlords Push Back

Creditors and landlords, Albanese says, are not enthusiastic. Landlords have been among the most vocal objectors because they see these orders as placing the risk of the case, especially the risk that the debtor becomes administratively insolvent and unable to pay its operating expenses, on their backs. While the debtor occupies the space, the automatic stay keeps landlords from evicting it or reletting the property. Mothballing does not wipe out these obligations, however. When the period expires, the debtor must pay the rent and other post-petition expenses it incurred. The benefit is extra breathing room from creditors during a period of great uncertainty, on top of the breathing room a bankruptcy filing already provides.

What to Know Now

Albanese describes mothballing as new to the COVID era, the product of creative lawyering with Code provisions that had long been available, and she expresses the hope that courts would not need to offer it on a long-term basis. As stores reopened, courts lifted the suspensions and cases moved forward, and the practice is closely associated with the conditions of 2020. Sections 105(a) and 305(a) remain in the Code, so debtors facing a future crisis that freezes commerce may point to the pandemic orders as a model. Landlords and other creditors, for their part, can be expected to argue that suspension is extraordinary relief and to press for timely payment of post-petition rent. The episode offers a clear look at how flexible bankruptcy courts' equitable powers can be in an emergency.