Mothballing Bankruptcy Cases in the COVID-19 Crisis

Hourly headlines have chronicled the global financial fallout from the COVID-19 pandemic, ranging from predicting a recession to noting the devastation wrought by volatile markets, shuttered businesses, idled aircraft, furloughed or terminated employees, and expectations (yet to be borne out) that there will be a large uptick in bankruptcy filings across industries. Despite financial aid packages by governments and central banks, the precipitous drop in consumer spending and limited credit availability means that even companies that commenced chapter 11 cases pre-pandemic are finding that their prepetition strategies may be undone by factors beyond their control. This problem particularly impacts nonessential brick-and-mortar retailers, which, in addition to the recent contraction of consumer demand for certain discretionary products, were already confronting a challenging outlook because of the growth of online commerce and other factors.

As courts of law and equity, bankruptcy courts have always had the inherent power to delay proceedings by taking matters under advisement—either to allow parties time to reach a consensual resolution or to enable facts and circumstances to evolve. Recently, however, bankruptcy courts were confronted with requests by debtors to temporarily suspend their cases under the courts' equitable powers and a seldom used provision of the Bankruptcy Code: 11 U.S.C. § 305(a). On March 27, 2020, and again on April 30, a New Jersey bankruptcy court temporarily suspended the chapter 11 cases of Modell's Sporting Goods, Inc., and its affiliated debtors (collectively, "Modell's"), which were in the process of conducting going-out-of-business sales. See In re Modell's Sporting Goods, Inc., No. 20-14179 (VFP) (Bankr. D.N.J.) (orders dated Mar. 27 and Apr. 30, 2020). The Delaware bankruptcy court presiding over the chapter 11 cases of restaurant and brewpub chain CraftWorks Parent LLC and its affiliates (collectively, "CraftWorks") and the Virginia bankruptcy court overseeing the chapter 11 cases of home-furnishing retailer Pier 1 Imports Inc. and its affiliates (collectively, "Pier 1") recently granted similar relief, mothballing the debtors' bankruptcy cases (over the objections of landlords and various other creditors) in an effort to weather the COVID-19 storm and, hopefully, preserve value for all creditors. See In re CraftWorks Parent, LLC, No. 20-10475 (BLS) (Bankr. D. Del. Mar. 30, 2020); In re Pier 1 Imports, Inc., No. 20-30805 (KRH) (Bankr. E.D. Va.) (orders dated Apr. 2 and Apr. 28, 2020). In short, these debtors were able to persuade the courts that a temporary pause in the proceedings will give them an opportunity to resurrect their prepetition restructuring plans.

At the other end of the spectrum is In re Art Van Furniture, LLC, No. 20-10553-CSS (Bankr. D. Del. Mar. 8, 2020). In that case, the pre-pandemic plan of the debtors (collectively, "Art Van") involved reducing its overall operational footprint and emerging with a rightsized balance sheet. Unfortunately, the case was filed only days before state and local governments issued social-distancing and stay-at-home directives. Art Van sought to follow CraftWorks, Modell's, and Pier 1 and pause the case, but it was unable to propose a viable path forward that garnered the support of Art Van's secured creditors and other stakeholders. Thus, to avoid administrative insolvency, Art Van moved to convert the cases to chapter 7, which the court approved on April 6, 2020.

Dismissal or Suspension of a Bankruptcy Case Under Section 305

Section 305 of the Bankruptcy Code provides as follows:

(a) The court, after notice and a hearing, may dismiss a case under this title, or may suspend all proceedings in a case under this title, at any time if—

(1) the interests of creditors and the debtor would be better served by such dismissal or suspension; or

(2)(A) a petition under section 1515 for recognition of a foreign proceeding has been granted; and

(B) the purposes of chapter 15 of this title would be best served by such dismissal or suspension.

(b) A foreign representative may seek dismissal or suspension under subsection (a)(2) of this section.

(c) An order under subsection (a) of this section dismissing a case or suspending all proceedings in a case, or a decision not so to dismiss or suspend, is not reviewable by appeal or otherwise by the court of appeals under section 158(d), 1291, or 1292 of title 28 or by the Supreme Court of the United States under section 1254 of title 28.

Other provisions of the Bankruptcy Code also authorize the bankruptcy court to dismiss cases filed under chapters 7, 9, 11, 12, and 13. See 11 U.S.C. §§ 707, 930, 1112, 1208, and 1307. These provisions permit the court to dismiss a bankruptcy case for "cause" and include nonexhaustive catalogues of the circumstances under which cause exists, many of which involve the debtor's misconduct.

Except for a municipal bankruptcy under chapter 9, to which section 305 does not apply (see 11 U.S.C. §§ 103(f) and 901(a)), dismissal of a case under chapters 7, 11, 12, and 13 may be sought under section 305(a) as well. Dismissal under section 305 "is reserved for those rare occasions when both the creditors generally and the debtor itself are better served by dismissal or suspension." Collier on Bankruptcy ("Collier") ¶ 305.01[1] (16th ed. 2020). Such occasions may include the filing of an involuntary bankruptcy by disgruntled creditors in an out-of-court restructuring, a bankruptcy filing prompted by a two-party dispute between the debtor and a creditor pending in a nonbankruptcy forum, or a bankruptcy filing without any "true bankruptcy purpose (e.g., debt adjustment, breathing spell from creditors, and need for discharge and fresh start)." Id. at ¶ 305.02[2] (citing cases). Although a bankruptcy court may revoke an order recognizing a foreign bankruptcy proceeding under chapter 15 pursuant to section 1517(d), section 305(b) is the only provision authorizing the dismissal of a chapter 15 case.

Most courts employ a "totality of the circumstances" test in determining whether to grant relief under section 305. See In re Northshore Mainland Servs., Inc., 537 B.R. 192, 203 (Bankr. D. Del. 2015). Factors relevant to such an inquiry include: 

(1) the economy and efficiency of administration; 

(2) whether another forum is available to protect the interests of both parties or there is already a pending proceeding in state court;

(3) whether federal proceedings are necessary to reach a just and equitable solution;

(4) whether there is an alternative means of achieving an equitable distribution of assets;

(5) whether the debtor and the creditors are able to work out a less expensive out-of-court arrangement which better serves all interests in the case;

(6) whether a non-federal insolvency has proceeded so far in those proceedings that it would be costly and time consuming to start afresh with the federal bankruptcy process; and

(7) the purpose for which bankruptcy jurisdiction has been sought.

Id. (citations omitted); accord In re Monitor Single Lift I, Ltd., 381 B.R. 455, 464–65 (Bankr. S.D.N.Y. 2008). These factors are not exclusive. Although "no one factor is more important than another," In re EB Holdings II, Inc., 589 B.R. 704, 727 n.73 (Bankr. D. Nev. 2017), the factors may be given different weight, depending on the circumstances of the case. Monitor, 381 B.R. at 465.

Section 305 is entitled "Abstention." However, the relief it authorizes—suspension or dismissal of a case—is distinct from the court's discretion or obligation to "abstain" from hearing a particular "proceeding" in a bankruptcy case (e.g., an adversary proceeding, a contested matter, or another discrete controversy, however denominated) under the permissive and mandatory abstention rules set forth in 28 U.S.C. §§ 1334(c)(1) and 1334(c)(2), which apply when another forum is or may be more appropriate. Abstention under section 305 "is of the entire case and reflects Congress's recognition that there may be situations where creditors and the debtor would be better served outside of bankruptcy." Collier at ¶ 305.01[1].

Most decisions regarding relief under section 305 involve dismissal of a bankruptcy case. However, some courts have suspended all proceedings in a case if suspension, rather than dismissal, is in the best interests of the debtor and creditors under the particular circumstances involved. See, e.g., In re Vega, 2019 WL 4896938 (Bankr. D.P.R. Oct. 3, 2019) (denying reconsideration of an order suspending a bankruptcy case under section 305(a) until resolution of a dispute regarding a creditor's proof of claim in a nonbankruptcy court); In re Gen. Aeronautics Corp., 594 B.R. 442 (Bankr. D. Utah 2018) (suspension of the involuntary bankruptcy case of a purported debtor for 60 days was appropriate, given the good-faith efforts of the debtor to settle some of the petitioning creditors' claims, the expense of bankruptcy, the harm it could cause to the debtor, and the likelihood that the debtor would achieve success on another project); EB Holdings II, 589 B.R. at 728 (suspending a contested involuntary chapter 11 case pending the resolution of state court litigation to determine the enforceability of a loan agreement that was the basis for the involuntary petitioners' claims); In re All. Fin. Capital Holdings, Inc., 2008 WL 294974 (Bankr. N.D. Cal. Jan. 31, 2008) (suspension of a chapter 11 case to permit settlement efforts to continue in state court); In re Curtis Papers, Inc., 2008 WL 111314 (Bankr. D.N.J. Jan. 9, 2008) (involuntary chapter 7 case suspended to permit completion of an assignment for the benefit of creditors, followed by revocation of the suspension order, conversion of the case to chapter 11, and a bankruptcy auction of the debtor's assets); In re Cenargo Int'l, PLC, 294 B.R. 571 (Bankr. S.D.N.Y. 2003) (suspension of a chapter 11 case under the pre-chapter 15 predecessor of section 305(a)(2) in deference to an English insolvency proceeding involving the same debtors); Matter of Axona Int'l Credit & Commerce Ltd., 88 B.R. 597 (Bankr. S.D.N.Y. 1988) (a foreign debtor's involuntary chapter 7 case would be suspended under the pre-chapter 15 predecessor to section 305(a)(2), with the assets of the estate turned over to Hong Kong liquidators for distribution in a Hong Kong winding-up proceeding, where Hong Kong law provided a comprehensive procedure for the orderly and just treatment of all creditors, and the Hong Kong liquidators were best situated to evaluate creditor claims fairly and at minimum expense), aff'd, 115 B.R. 442 (S.D.N.Y. 1990), appeal dismissed, 924 F.2d 31 (2d Cir. 1991).

The bankruptcy courts in Modell's, CraftWorks, and Pier 1 recently considered requests to suspend chapter 11 cases either entirely or in part because of the COVID-19 pandemic.

Modell's

Modell's filed for chapter 11 protection on March 11, 2020, in the District of New Jersey for the purpose of closing all of its 134 sporting goods locations in a controlled liquidation. Unfortunately, the beginning of that process coincided with the onset of the COVID-19 emergency. Because sporting goods stores are not deemed essential businesses, state directives shuttered the company's stores shortly after the bankruptcy filing date, effectively preventing the liquidation sales from proceeding.

In an effort to preserve value for stakeholders and maintain the status quo, Modell's, with the support of its lenders and the official unsecured creditors' committee, sought court authority to suspend its chapter 11 cases for 60 days under section 305(a). In its motion, Modell's stated that, upon the expiration of the COVID-19 emergency, it could resume operating and complete the liquidation process. Several Modell's landlords objected to suspension of the cases, arguing that, without any rent for several months, suspension would effectively make them unprotected forced lenders with little prospect of recouping their losses.

On March 27, the bankruptcy court issued an order suspending the chapter 11 cases until April 30. The order provides, among other things, that during the suspension period: (i) Modell's will cease operating; defer payment of all nonessential expenses, including rent; terminate most store, distribution center, and corporate employees; and operate in accordance with a bare-bones cash collateral budget with limited expenditures; (ii) all deadlines in the bankruptcy case will be extended until further notice; (iii) the automatic stay shall remain in full force and effect; and (iv) Modell's will continue to provide adequate protection to its prepetition lenders.

Certain landlords attempted to appeal the bankruptcy court's order. Modell's claimed the appeal was "frivolous" because suspension orders may not be appealed pursuant to section 305(c) of the Bankruptcy Code.

On April 20, the court granted Modell's request to extend the existing suspension order through and including May 31, 2020.

CraftWorks

CraftWorks has operated restaurants and brewpubs in more than 330 locations under various names, including Logan's Roadhouse, Old Chicago, Rock Bottom, and Gordon Biersch. After closing 40 underperforming locations, CraftWorks filed for chapter 11 protection in the District of Delaware on March 3, 2020, with a pre-negotiated plan to sell 260 of its best-performing locations for $138 million to senior lender Fortress Investment Group LLC ("Fortress"). That plan was thwarted at the onset of the COVID-19 emergency, when CraftWorks was forced to idle its restaurants and brewpubs because of social-distancing decrees, and evaporating cash triggered a default under CraftWorks' debtor-in-possession financing facility. CraftWorks then furloughed most of its 18,000 employees.

On March 20, 2020, CraftWorks, supported by its official unsecured creditors' committee, sought court authority to:

suspend as much of [its] operations—and related administrative expenses—as feasibly possible and cut expenses to the bare minimum, in hopes of re-starting [its] operations and re-opening [its] stores at some point in the future when the need for restaurants to be closed in order to combat the COVID-19 crisis will hopefully have passed. 

The motion sought approval under section 105(a) of the Bankruptcy Code and various other provisions to implement temporary procedures to accomplish that goal for 30 days, subject to an extension of an additional 30 days. Those procedures include mandatory conferences prior to commencing litigation, along with telephonic hearings and streamlined procedures governing the rejection of contracts and leases; requests for modification of the automatic stay; and requests for payment of administrative claims—all with the aim of minimizing administrative expenses.

The bankruptcy court granted the motion on March 30. In its order, the court noted that the relief was warranted in light of the COVID-19 pandemic and related events, "which constitute compelling circumstances to modify procedural rules in the Chapter 11 Cases while balancing the rights of [CraftWorks and its estate], on the one side of the scale, and the rights of creditors and other parties in interest, on the other side of the scale." Although CraftWorks did not expressly rely on section 305(a) as authority for the relief requested in its motion, the court's order provides that "[n]othing herein shall prejudice [CraftWorks'] rights, if any, for relief under section 305 of the Bankruptcy Code and any opposition to such relief by any creditor or party in interest in these Chapter 11 Cases and all such rights are reserved."

On May 20, 2020, the bankruptcy court approved the sale of CraftWorks to Fortress, which submitted a $93 million credit bid and pledged to keep at least 150 restaurants in operation.

Pier 1

U.S. and Canadian home-furnishing chain Pier 1 filed for chapter 11 protection on February 17, 2020, in the Eastern District of Virginia with plans to sell the company. At the time of the filing, Pier 1 had struck a deal with lenders that set a cash recovery price on their claims of $105 million, representing 55 cents on the dollar, from the proceeds of an anticipated bankruptcy auction of the company's assets. Under the agreement, lenders agreed that if there was a bid for Pier 1's assets that generated at least that much, they would automatically support the sale. Otherwise, the lenders would decide whether to take control of Pier 1 or proceed with an auction at which they could credit-bid their debt.

Because of the COVID-19 crisis, Pier 1 temporarily closed all of its stores as well as a number of distribution centers; furloughed employees; and cut wages to preserve liquidity. It also cancelled (or at least postponed) the bankruptcy auction of its assets scheduled for March 30 after no qualified bids were received by the bidding deadline and the lenders opted to swap their debt for equity in the reorganized company.

On March 31, 2020, Pier 1 filed a motion with the bankruptcy court seeking authority under section 105(a) and/or section 305(a) of the Bankruptcy Code to "temporarily cease making or delaying all [] payments" not expressly provided for in a revised budget agreed to with lenders, limiting payments to "critical" expenses and implementing case procedures that would adjourn stay relief and certain other motions for an unspecified, open-ended "limited operations period." In its motion, Pier 1 stated that the challenges from the COVID-19 emergency were "especially acute" for retailers in chapter 11 and asserted that the requested relief "is absolutely vital to the Debtors' efforts to facilitate a going-concern sale or debt-for-equity exchange"—an outcome that "is still a possibility." Such relief, Pier 1 claimed, would give creditors "the best opportunity to have a going-concern partner at the conclusion of these chapter 11 cases." Pier 1 also stated that "[i]t is prudent for these and other debtors to seek the relief requested herein in an effort to maximize value," consistent with the relief granted by the courts in Modell's and CraftWorks to "mothball" the debtors' operations and minimize expenses.

According to Pier 1, the bankruptcy court could approve its interim budget and permit deferred payments pursuant to its "broad equitable powers" under section 105, which "permits the Court to extend the principles of the Bankruptcy Code to postpetition case administration." However, Pier 1 noted, "[t]o the extent that the Court determines that section 305 is the appropriate basis for relief, the Debtors respectfully request that the Court grant this Motion pursuant to section 305 of the Bankruptcy Code."

The bankruptcy court granted Pier 1's motion on April 2 over the objection of several of Pier 1's landlords, which are not being paid rent. By order dated April 28, 2020, the court extended Pier 1's limited-operations period until May 31.

On May 19, 2020, Pier 1 determined that any plans to restructure its business and continue as a going concern were rendered impossible by the continuing COVID-19 crisis. It accordingly sought court authority to wind down its operations and liquidate its assets.

Art Van

Art Van filed for chapter 11 protection in early March, citing extreme market conditions for the filing and listing more than $200 million in debt. The company filed for bankruptcy with plans to shutter all but 44 of its stores and to sell the remaining stores as a going concern. However, Art Van closed all 169 of its retail locations on March 19 after the governors of Michigan, Maryland, Pennsylvania, and certain other states imposed restrictions on the operation of nonessential businesses in an effort to slow the advance of COVID-19. The shutdowns stopped the store-closing sales, and Art Van abandoned its plan for a going-concern sale.

In Art Van's April 3, 2020, motion seeking conversion of its chapter 11 cases to chapter 7, the company stated that, although it initially wished to seek court authority "to 'mothball' [its] remaining assets and operations and to suspend substantially all activity in these chapter 11 cases until such time as the broader economic and public safety situations stabilized and hopefully improved," Art Van abandoned this course of action after "no viable path forward in chapter 11 emerged that would garner the support of [Art Van's] senior secured lenders and certain other stakeholders." As noted, the bankruptcy court granted the conversion motion on April 6.

Outlook

In ordinary times—and even during the financial crisis of 2008–2009—bankruptcy courts expect debtors to keep cases moving apace. See Taggart v. Lorenzen, 139 S. Ct. 1795, 1803 (2019) ("a chief purpose of the bankruptcy laws [is] to secure a prompt and effectual resolution of bankruptcy cases within a limited period" (internal quotation marks and citations omitted). The relief granted in Modell's, CraftWorks, and Pier 1 illustrates that courts recognize the ongoing economic and operational damage wrought by COVID-19. Accordingly, debtors, creditors, other interested parties, and bankruptcy courts may have in section 305(a) a new tool for providing a breathing spell to get past the pandemic as long as the case stakeholders and court are convinced that such a "pause" is not simply a delay tactic to avoid an inevitable liquidation.

While it is impossible to determine when the pandemic will subside, there may come a time when the ongoing interruption to a bankruptcy case is so detrimental—whether, for example, because asset values nosedive or secured creditors' interest accrues at default rates such that there is no value for other creditors—that suspending the case destroys value to all parties-in-interest. Thus, while bankruptcy courts appear to embrace the "wait and see" approach for now, there may come a time when a court requires the debtor to justify the hiatus by demonstrating that there will be viable restructuring options when the case resumes.

Alternatively, as illustrated by Art Van, pausing the case may not be a viable option.