Twenty-Five Years Later: Two Critical Bankruptcy Code Amendments for Equipment Lessors

by Lesley Anne Hawes Monitor 100 2016

Until 1994, equipment lessors received very little respect in the bankruptcy court system created by the 1978 Bankruptcy Act. Two Congressional amendments restored their rights and enabled them to retain the value of their property. Attorney Lesley Anne Hawes recalls the two amendments that created certainty for equipment lessors.

Lesley Anne Hawes,
Partner,
Dentons

The Monitor 100 launch occurred 13 years after the enactment of the Bankruptcy Code of 1978, a historic overhaul of the Bankruptcy Act of 1898. The 1978 reforms established separate bankruptcy courts with sweeping powers. Previously, district courts had handled bankruptcy cases with the help of court-appointed referees. In 1980, the Marathon Pipeline decision, which challenged the new court figuration, created jurisdictional chaos when the Supreme Court decided that the broad jurisdiction granted to the bankruptcy courts with non-Article III, non-life-tenure judges was unconstitutional. The conflict was resolved by amending the jurisdictional statutes and rules. Bankruptcy filings became a rapidly expanding workout strategy employed by both business and individual debtors facing defaults and financial distress.

In 1994, Congress made significant revisions to the Bankruptcy Code to address a number of inconsistent judicial rulings and critical concerns of personal property lessors regarding the interpretation and application of the revised Bankruptcy Code. These amendments remain among the most significant legislation benefiting equipment lessors, withstanding subsequent amendments to the statute. They remain key components in the balance between the interests of debtors seeking a “fresh start” and secured creditors and personal property lessors seeking to preserve their rights and collateral during bankruptcy proceedings. Certain key amendments in the 1994 legislation created important rights for equipment lessors that changed the bankruptcy landscape for personal property lessors.

Adequate Protection for Personal Property Lessors

Today it seems almost inconceivable that anyone could doubt that equipment lessors and other personal property lessors are entitled to adequate protection of their interests during the pendency of a bankruptcy case. Yet, before the enactment of the 1994 amendments to section 363, there was a significant split among the courts on that issue. Section 363 of the Bankruptcy Code governs the debtor’s use, sale or lease of property post-petition. It authorizes the debtor to use, sell and lease property in the ordinary course of its business. Section 363(e) stipulates that the court can prohibit or condition the debtor’s use, sale or lease of property post-petition by requiring the debtor to provide adequate protection to a party who has an interest in the property that is being used, sold or leased.

Some courts held that personal property lessors were not entitled to adequate protection for the use of their property by the debtor post-petition. Those courts held that section 365 governing assumption or rejection of executory contracts and unexpired leases constituted the primary source of rights for personal property lessors to obtain post-petition payments or other protections of their property interests during the case. However, other courts held that personal property lessors were entitled to seek adequate protection of their interests under section 363(e) and that section 365 was only one of the Bankruptcy Code statutes available to a personal property lessor to protect its rights during the case.

In 1994, Congress resolved this dilemma after intense lobbying by the equipment leasing industry and other creditor organizations. Congress made section 363(e) explicit in its protection of equipment lessors by amending the statute to read, “This subsection also applies to property that is subject to any unexpired lease of personal property (to the exclusion of such property being subject to an order to grant relief from the stay under section 362).”

The notion that personal property lessors are as entitled to adequate protection of their property interests during the case as any other party seems noncontroversial today. In fact, it seems obvious that equipment lessors in particular are substantially at risk of loss during a bankruptcy case since equipment tends to deteriorate physically and monetarily more rapidly than real property or other intangible assets. Nevertheless, it took an amendment to the Bankruptcy Code to ensure that right was available to personal property lessors.

Post-Petition Protection

The other key amendment to the Bankruptcy Code that helped change the landscape of bankruptcy for equipment lessors was the addition of section 365(d)(10), which governs the effect of bankruptcy on executory contracts and unexpired leases. Before the code’s 1994 amendments, the rights of equipment lessors during bankruptcy were uncertain, and treatment of personal property leases during bankruptcy cases was not standardized across the country. Some courts held that personal property lessors were not entitled to adequate protection, and other courts held that equipment lessors had no right to require the debtor to perform its monetary or nonmonetary obligations under the lease post-petition.

In some jurisdictions, the only remedy the personal property lessors had was seeking an order setting an early deadline for the debtor to assume or reject the creditor’s personal property lease. That remedy was often untenable, particularly in large Chapter 11 proceedings with numerous creditors, numerous leases and an uncertain future for the debtor. Courts would balance the interests of the debtor and the larger creditor body, on one hand, including the injury to the estate that could result if the debtor prematurely assumed a lease leading to potential administrative liability if the debtor later defaulted or the case was converted to Chapter 7. On the other hand were the concerns of the equipment lessor whose collateral may be substantially diminishing in value and whose opportunity to re-let the equipment to realize the full economic value of the property was likely disappearing.

Congress ultimately acknowledged the abuse equipment lessors were suffering in many instances in Chapter 11 cases and acted by adding section 365(d)(10) to the code. That section requires the debtor to perform all obligations of a personal property lease arising under the lease from and after 60 days after commencement of the case. The only exception to that rule is that the debtor is not required to cure insolvency-related defaults under section 365(b)(2), including satisfying any provision relating to a penalty rate or default based on a failure to perform nonmonetary obligations under the lease under section 365(b)(2). As a result of this addition to the Bankruptcy Code, equipment lessors have the right to receive payments and to be assured that the debtor is complying with maintenance, repair, insurance and other obligations regarding the equipment post-petition, at least starting 60 days after the petition date.

Conclusion

The protections personal property lessors gained through these 1994 amendments are given little thought today, as those rights have become ingrained in the expectations of both debtors and personal property lessors. But these provisions were cheered when they were enacted 22 years ago. They were widely and accurately viewed as restoring an appropriate balance between debtors and creditors under the Bankruptcy Code and creating certainty and predictability for personal property lessors that had not existed before.

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