The COVID-19 virus and government shut-downs have triggered a historic wave of bankruptcies in the United States. Faced with profound economic uncertainties, companies have begun requesting and bankruptcy courts are increasingly employing a new tool in bankruptcy referred to as “mothballing.” Bankruptcy mothballing, as the name suggests, offers companies a pause in the Chapter 11 process during which certain obligations such as rent or debt payments are frozen or "mothballed." We sat down with Rachel Albanese, a bankruptcy partner at the global law firm DLA Piper, to discuss how bankruptcy courts are using this tool to offer temporary relief to companies facing uncertainty and to learn more about the mechanics and implications of bankruptcy mothballing.
Rachel Albanese is a Restructuring partner at DLA Piper. She represented Valeritas Holdings, Inc. in its chapter 11 case, the first chapter 11 case in the country to attribute COVID-19 as one of the factors leading to the filing.
Bankruptcy Mothballing a Definition
Bankruptcy mothballing is a legal tool by which bankruptcy courts grant companies in Chapter 11 a period of relief from their responsibilities to creditors by pausing or “mothballing” the process. Typically, after filing for bankruptcy a company must pay its creditors all operating expenses accrued during the time following the filing. However, due to the uncertainty facing companies given the COVID-19 crisis, courts have accepted requests mothball. Judges are empowered to do so by 11 U.S. Code § 305 of the Bankruptcy Code authorizing judges to suspend proceedings when the interests of creditors or debtors would be “better served” by such a suspension.
How Do Courts Determine Whether Mothball?
According to Albanese, bankruptcy courts employ a “totality of the circumstances” test, evaluating whether a suspension will allow the company to more effectively reorder or liquidate. Under a totality of the circumstances test, courts look to all available information to determine the fairest outcome rather than deciding based on one particular factor. This test looks at the interests of the company as well as creditors.
How Long Does Mothballing Last?
Relief under mothballing is temporary, usually lasting a period of months. According to Albanese, common mothballing periods have been 30, 60, or 90 days with some companies requesting and receiving extensions when the relief expires.
Does Mothballing Extinguish Obligations?
No, mothballing is simply a pause in Chapter 11. According to Albanese, bankruptcy mothballing doesn’t wipe debts, it’s key impact is that it “provides the debtor with extra breathing room during a period of great uncertainty.” That said, once the mothballing period concludes, the company is obligated to pay its obligations including obligations incurred during the mothballing period.
Mothballing Winners and Losers
Ideally, mothballing helps both the creditors and the debtor in a bankruptcy case by giving the debtor necessary “breathing room” to eventually pay down its debt or liquidate at maximal value. With the current unexpected circumstances of the COVID-19 shutdowns, companies are asking for extra time, for example, to hold liquidation sales (as was the case with Modell’s Sporting Goods). Creditors, however, may not view mothballing as serving their interests. According to Albanese, landlords in particular have been among the most vocal critics of the practice and have in some cases argued that it unfairly shifts risk to them. The landlord of a business mothballed by a bankruptcy court, afterall, must forgo collection of rent with no guarantee that the business will be capable of repayment it in the future.
Joel Cohen ("JC"): With the economic disruption of COVID-19, America is facing a historic wave of bankruptcies. Today we’ll take a look at a new trend in bankruptcy that is sometimes referred to as mothballing. Hello and welcome to Talks On Law, I’m Joel Cohen. Today we’re joined remotely by Rachel Albanese, a bankruptcy partner at the global law firm DLA Piper. Rachel, welcome to Talks On Law.
Rachel Albanese("RA"): Thanks Joel, it’s a pleasure to be here.
JC: Before we jump into mothballing, maybe you can give us a quick overview. What are you seeing in terms of bankruptcy trends today?
RA: 2020 has seen an unprecedented number of bankruptcy filings, not just really large companies but also across industries. We’ve seen cases in oil and gas, health care, restaurants and particularly retail, which is where we’re seeing the mothballing phenomenon.
JC: What exactly do you mean by mothballing?
RA: Mothballing is essentially a pause in a Chapter 11 case. Ordinarily when a debtor files Chapter 11, it’s required to pay all of its operating expenses post-petition, which is the period following the bankruptcy filing. When a debtor files a motion for what we call “mothballing” relief, it’s. seeking to put its case into suspension.
JC: They’re getting a timeout. And is that period indefinite or are we talking about a number of weeks or months?
RA: Courts will grant mothballing for a certain period of time. It’s not indefinite. In certain cases they’ve granted relief for 30, 60, 90 days, and then upon expiration of that initial period debtors can seek to extend it for some limited duration.
JC: When it comes to granting this type of relief, what’s the legal basis that companies are relying on?
RA: Bankruptcy courts, which are courts of equity, are entitled to grant this kind of relief under two sections of the bankruptcy code. One is section 105a, which is a broad grant of equitable discretion, and section 305a, which authorizes a bankruptcy court to suspend or dismiss a bankruptcy case in the interest of justice.
JC: And it’s that suspension that gives rise to the term “mothballing”?
RA: Exactly. And bankruptcy sites will generally employ a totality of the circumstances test in determining whether the relief is appropriate. We’ve seen that bankruptcy courts have been willing to grant this kind of relief during the pandemic due to, particularly in retail cases, reduced foot traffic and uncertainty of outcome.
JC: Can you share with us a couple of examples where you’ve seen mothballing in recent bankruptcies?
RA: One of the earliest examples of mothballing relief was in the Modell’s Sporting Goods case, where the debtor was about to hold liquidation sales in its stores but following the shutdown order was not able to do that because stores were closed. Other cases in which mothballing orders have been entered are Pier 1, Craft Works, JCPenney, and Brooks Brothers, although in the latter they’re effectively seeking the same relief, which is, “the debtor is not obligated for some period of time to pay rent.”
JC:You mention rent, which brings me to the question of who are the losers when it comes to mothballing. WHat are the other parties involved, and how are they affected?
RA: As you can imagine, creditors and landlords are not enthusiastic about mothballing. Landlords have been some of the most vocal objectors to this type of request. And that's because they feel like these kinds of orders put the risk of the case, and primarily the risk of the debtor becoming administratively insolvent, meaning unable to pay its operating expenses, on the backs of the landlords. The landlords are unable to re-let the property while the debtor is using it, and they’re prevented by the bankruptcy code and the automatic stay from looking for new tenants.
JC: That’s an important aspect of mothballing, which is not only are the landlords not being paid, but they’re also unable to evict a tenant who may or may not be able to pay in the future.
RA: That’s right but although the debtor is required to pay any rent or other expenses and costs that it has incurred post-petition, when the mothballing expires.
JC: So to mothball does not mean to avoid, to wipe, these expenses from the balance sheet. It’s just a hold or a stay on when it needs to be paid.
RA: That’s right
JC: If the mothballing doesn't actually expunge any debt obligations, what benefits does it really offer any of the companies?
RA: The filing of a bankruptcy case provides debtors with necessary breathing room and space from its creditors collection efforts. These mothballing procedures often will provide the debtor with extra breathing room during a period of great uncertainty
JC: And this strategy of mothballing, is this something that's been going on for a long period of time, or is this new to the post-covid era?
RA: It’s new to the post-covid era, but the bankruptcy code provisions that permit the courts to grant this kind of relief have been there, and it’s just due to creative lawyering that it has come about.
JC: And before we let you go, maybe we can get your insight on what you predict in terms of this trend. Are courts likely to continue to offer this kind of relief going forward?
RA: Let’s hope that courts don’t need to offer this kind of relief on a long-term basis, but as long as this covid crisis continues, I think the bankruptcy courts will be willing to offer this kind of relief to debtors who need it
JC: Rachel Albanese, thank you for joining us today and explaining a bit about bankruptcy mothballing.
RA: My pleasure Joel. Thanks for having me.