No equipment lessor wants to find itself a creditor of a lessee in a reorganization case under chapter 11 of the U.S. Bankruptcy Code (the Bankruptcy Code). However, when such a situation arises, a lessor is not without recourse – even where the facts give rise to situations not specifically addressed by the Bankruptcy Code. This post considers two scenarios highlighting the exposure creditor-lessors may face in the bankruptcy context and provides guidance for minimizing risk of losses: first, when a debtor-lessee continues to use the subject equipment without payment; and second, where the debtor-lessee no longer uses the subject equipment but has not rejected the underlying lease.
The treatment of unexpired leases and executory contracts (which encompasses equipment leases) is codified in section 365 of the Bankruptcy Code. Section 365 provides, in relevant part, that a chapter 11 debtor-lessee is required to perform under the equipment lease after 60 days from entry of the order of relief until the lease is assumed or rejected. A chapter 11 debtor-lessee may assume or reject an equipment lease any time before confirmation of the chapter 11 plan. The time period between the bankruptcy filing and the time the equipment lease is assumed or rejected is, in effect, the “limbo period.” With the exception of the debtor-lessee’s obligations under section 365(d)(5), during the limbo period, the lease is enforceable by, but not against, the debtor-lessee. Accordingly, it is in this limbo period where equipment lessors can be most vulnerable to non-payment and depreciation in the value of the equipment, for example through continued use or lack of maintenance. It is this exact potential exposure that section 365(d)(5) should minimize. Yet, as the hypothetical scenarios illustrate, provisions of the Bankruptcy Code may assist in minimizing lessors’ potential losses, but lessors must play an active role to maximize the protections afforded by the Bankruptcy Code.
Consider the following:
- A lessee files for bankruptcy protection, continues to use equipment subject to a lease, but does so without making payments (or without making the full contract-rate payment) to the lessor during the limbo period. What recourse, if any, does the lessor have?
- A lessee files for bankruptcy protection, does not make any payments to the lessor, but is not using the subject equipment. What can the lessor do?