As our country and our state move out of the extended chill of the Covid-19 lockdown, commentators note that two economic realities are going to collide this summer.  First, unless the federal government acts, the COVID-19 related payments to businesses and unemployment benefits will end.  A recent article in the Wall Street Journal noted that these payments have provided a somewhat false sense of security and prosperity.  Second, as businesses reopen many may find that the economics simply no longer work.  With this as a background the topic this month is bankruptcy, and what ports should expect.  I relied on Todd Egland who heads our firm’s bankruptcy practice to prepare this column.

Bankruptcy describes a body of federal law which tries to balance the rights of creditors and debtors.  Those rights are adjudicated in federal bankruptcy courts by federal bankruptcy judges who serve fourteen-year terms and are appointed by the U.S. Court of Appeals with jurisdiction over the state – here the 9th Circuit.  The judges typically are bankruptcy law practitioners.  The power of the bankruptcy court is invoked when a business files a petition for bankruptcy either under chapter 7 of the bankruptcy code (a business liquidation) or chapter 11 of the bankruptcy code (a business reorganization).[1] The vast majority of business bankruptcy cases are filed as a chapter 11 reorganization.  If the reorganization fails a business or the court can convert the case to a chapter 7 liquidation where assets are sold, and business is terminated.  Normally business management stays in control of the business during this process, although the court can remove management and appoint a trustee to run or liquidate the business.  The time before the date of the petition is cleverly named “pre-petition” and the time after filing is similarly named “post-petition”.

When a business files a petition for bankruptcy in federal court, federal law imposes an “automatic stay,” which is an order from the bankruptcy court to immediately stop any lease enforcement actions.  Port districts are landlord creditors and are afforded no special protection because they are governments.  Indeed, as explained below, experience shows that port districts landlords are held to a higher standard because they are a government.

After a petition is filed, the “bankruptcy estate” (the assets and liabilities of the business are the bankruptcy estate) has 120 days to decide to assume or reject the leases of the business.  This period can be extended by up to 90 days by court order.  However, during this post-petition period the tenant must stay current on the rents and other financial obligations (insurance and leasehold excise tax).  If the tenant falls behind it is possible for a port district to seek “relief from the automatic stay” to terminate the lease.  But--good luck.  My experience is that bankruptcy court judges will not grant this relief (at least the first time they are asked) and always note that port districts are governments and therefore can absorb the loss easier.

In any event, the tenant will eventually have a plan approved by the court to reorganize its debts (including paying the pre-petition rents over time) or not.  If the plan is not approved the tenant usually converts the case to a chapter 7 and goes out of business.  This process, depending on the size of the tenant can take months to years.  The plan may include assigning the port lease to a new tenant.  This can be done without port approval.

With that background in mind here are a few pointers:

• Consider a very narrow use provision in port leases.  This make it much more difficult to assign a lease to a different type of user without the port commission’s permission.

• Consider a personal guaranty for lease payments or a portion of lease payments (for example – six months of lease payments) from the business owners.  This can really help focus the business owner on paying the port.

• Before a tenant gets to bankruptcy there are usually plenty of signs of distress.  Act proactively to either help the tenant or move quickly to default the tenant and cut the port’s losses.

• After a tenant files for bankruptcy be prepared for “let’s make a deal” (maybe in a public commission meeting with pleas to preserve jobs or stretch out payments or have the port take a “haircut” on past due rent).  Best to start thinking in advance on how the port will react before the bankruptcy lawyers and the tenant come calling.  For larger tenants this should involve a public relations strategy.

• Cash security deposits or blocked accounts provided by a tenant belong to the bankruptcy estate and must be turned over by the port.  Lease bonds are a separate contract between the port district and the bonding company and are not changed by the bankruptcy.  Therefore, lease bonds are much better for a port than cash deposits or blocked accounts.  Make sure to copy the bonding company on notice as to any default notice issued to a tenant or if a bankruptcy occurs.

• Most importantly, have the port’s general counsel engage competent bankruptcy counsel.  This is a very specialized area of law practiced by a relatively small group of lawyers. 

  As always, contact your port attorney for guidance and contact me if you have a topic for this column at  fchmelik@chmelik.com

[1] There are similar chapters for personal bankruptcies.