“‘Time Is On My Side’ — When a ‘Time of the Essence’ Closing Date Keeps Rolling Like a Stone for 60 Days”

The recent decision of the Bankruptcy Court for the Southern District of New York in In re AAGS Holdings LLC, Case No. 19-13029 (SMB) (Bankr. D. Del. Nov. 12, 2019), underscores the ability of debtors — and specifically, for purposes of this client alert, parties to real property purchase contracts — to take advantage of the Bankruptcy Code’s 60-day tolling period to get more time to close on a purchase despite a “time of the essence” (TOE) closing deadline. The SDNY Bankruptcy Court — which covers Manhattan’s vast real estate (as well as any debtor who can show a jurisdictional basis to file in SDNY) — held that a debtor’s bankruptcy petition is not filed in bad faith when the petition is filed in order to obtain a statutory 60-day extension of a TOE closing deadline. The decision underscores the need for sellers to consider the effect of this automatic bankruptcy extension when negotiating with buyers over the terms of a consensual closing extension (e.g., fees and increased deposits) even if the contract does not have a financing contingency.

What Happened?

Let’s start with the background. On July 17, 2019, the Debtor and the seller (the Seller) entered into an Agreement of Purchase and Sale (the PSA) whereby the Debtor agreed to purchase property (the Property) for $27.5 million. The Debtor signed the PSA and delivered a down payment of $100,000 in escrow. The PSA included a clause indicating that time was of the essence and provided that the closing must occur on Sept. 20, 2019, at 10:00 a.m. or at such time as may be adjourned by the Seller (the Closing Date). The PSA included three possible locations for the closing — the office of the Seller’s attorney, the office of the Debtor’s lender’s attorney, or through an escrow, but the parties ultimately agreed that closing would be virtual and the executed documents would be held in escrow and released on the Closing Date. If the closing did not occur by the Closing Date, the PSA did not terminate automatically; rather, the PSA gave the Seller the option to provide written notice of the PSA’s termination and retain the down payment. Even though the PSA did not have a financing contingency, the Debtor was unable to obtain the necessary financing by the Closing Date and attempted to adjourn it. The parties exchanged various emails negotiating the terms for a consensual extension of the Closing Date; the Seller would be “happy to grant an extension” in exchange for additional down payments for each week extending the Closing Date and a specific release of future litigation. (The Seller wanted an additional $500,000 for a one-week extension, another $500,000 for an additional one-week extension and $200,000 for a third one-week extension.) The Debtor advised that it could not meet these conditions, and the closing was not adjourned. The Debtor filed a Chapter 11 petition on Sept. 20, 2019, at 10:16 a.m. — 16 minutes after the time scheduled for closing in the PSA. 

The Seller filed a motion (the Motion) seeking a declaration that the automatic stay did not prohibit it from terminating the contract, arguing that the contract had terminated prepetition because the Debtor filed after 10:00 a.m. on the Closing Date. Because the Seller never gave notice of its election to terminate the PSA pre-bankruptcy, any effort to exercise its right to terminate post-bankruptcy would have violated the automatic stay and have been void. In the Motion, the Seller alternatively sought relief from the automatic stay to terminate the PSA or dismiss the bankruptcy case as a bad faith filing. 

The Debtor, meanwhile, had filed for bankruptcy to seek the necessary time under section 108 of the Bankruptcy Code to secure its financing and to be able to consummate the sale under a Chapter 11 plan. (More on Section 108 below.)

The PSA was governed by New York law. The court reviewed Second Circuit precedent from Law Debenture T. Co. of N.Y. v. Maverick Tube Corp., which articulated that under New York law, when asked to interpret contract language, the relevant inquiry is whether the contract’s language is ambiguous with respect to the dispute among the parties. 345 F.3d 154, 184 (2d Cir. 2003) (quoting Int’l Multifoods Corp. v. Commercial Union Ins. Co., 309 F.3d 76,83 (2d Cir. 2003)). A contract may be found to be ambiguous where it may give rise to more than one meaning when viewed objectively by a “reasonably intelligent person . . . who is cognizant of the customs, practices, usages, and terminology as generally understood in the particulate trade or business.” Int’l Multifoods, 309 F.3d at 83. The court also reasoned that where a dispute concerns a provision of the contract, the court must consider the contract as a whole to ensure that undue emphasis is not placed upon particular words and phrases. 

The court found that the term “Closing Date” as defined in the PSA was, in fact, ambiguous — it could mean Sept. 20, 2019, at 10:00 a.m. (as Seller argued) or just Sept. 20, 2019 (as the Debtor argued). The court reasoned that the Seller’s interpretation of looking to the specific time of the day could lead to an absurd result. The PSA contemplated that the closing may occur in person. If the parties were required to close by 10:00 a.m., the PSA would have had to indicate what time the parties must appear at the physical location to be able to close by 10:00 a.m., which it did not. Moreover, a closing may take time, or some other circumstances may extend the closing past 10:00 a.m. The court determined that the only sensible interpretation was that the closing was scheduled for 10:00 a.m., but “Closing Date” — for purposes of the TOE clause — referred only to the date itself (Sept. 20, 2019) rather than the time of day (10:00 a.m.). The court observed that even the Seller’s own actions supported this result. One day before the Closing Date, the Seller sent instructions to the escrow agent, which included a list of requirements that the Debtor had to meet and stated that if all of the requirements had not been satisfied by 5:00 p.m. on the Closing Date, the escrow agent was authorized to return escrowed documents to the Seller. For one hoping to say this was an isolated judicial interpretation, the court reasoned that other New York case law supported the conclusion that in deciding whether a party has breached a TOE clause, courts will look to the “law day” and not the time of day. Gray v. Wallman & Kramer, 585 N.Y.S. 2d 46, 48 (N.Y. App. Div. 1992). Accordingly, at the time of the Chapter 11 filing, the PSA was a live, executory contract which had not terminated prepetition and the Debtor was not in default as of the bankruptcy filing. 

Because the PSA was live, section 108(b) of the Bankruptcy Code operated to extend the Closing Date by 60 days. Section 108(b) states:

(b) Except as provided in subsection (a) of this section, if applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor or an individual protected under section 1201 or 1301 of this title may file any pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act, and such period has not expired before the date of the filing of the petition, the trustee may only file, cure, or perform, as the case may be, before the later of-

(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or

(2) 60 days after the order for relief.

Because the PSA had not terminated prior to the petition being filed on the Closing Date, the Debtor now had an additional 60 days to close under section 108(b) of the Bankruptcy Code.

As noted, the Seller sought alternative relief — to dismiss the case as a bad-faith filing under section 1121(b)(1) of the Bankruptcy Code because the sole/primary purpose of the filing was to get an extension of the closing under section 108(b). Let’s start with the legal standards: “cause” for dismissal may include a finding that a case was filed in bad faith. A finding of bad faith may also justify relief from the automatic stay. The court looked to Second Circuit precedent in Baker v. Latham Sparrowbush Assocs. (In re Cohoes Indus. Terminal, Inc.), which found that a petition is filed in bad faith when, on the petition date, it is evident that there is no reasonable likelihood that the debtor intended to reorganize and no reasonable probability that the debtor would emerge from bankruptcy. 931 F.2d 222, 227 (2d Cir. 1991). Furthermore, in C-TC, the Second Circuit identified several factors that support a finding that a Chapter 11 case was filed in bad faith:

• The debtor had only one asset.
• The debtor had few unsecured creditors with small claims in relation to secured creditors.
• The debtor’s one asset was subject to a foreclosure action resulting from arrearages or default on debt.
• The debtor’s financial condition was effectively a two-party dispute between the debtor and secured creditors, which could be resolved in the pending state foreclosure actions.
• The timing of the debtor’s filing evidenced an intent to delay or frustrate the legitimate efforts of the debtor’s secured creditors to enforce their rights.
• The debtor had little to no cash flow.
• The debtor could not meet current expenses, including personal property and real estate taxes.
• The debtor had no employees.

113 F.3d at 1311 (quoting Pleasant Pointe Apartments, Ltd. v. Kentucky Hous. Corp., 139 B.R. 828, 832 (W.D. Ky. 1992)). Note that many of these standards often apply to “single asset real estate” cases. Ultimately, the court concluded that an inquiry into whether a petition was filed in bad faith requires courts to consider the totality of the circumstances, with no one dispositive factor. Here, several C-TC factors were present — i.e., the Debtor had only one asset (the PSA); it did not appear to have cash flow or employees; its scheduled unsecured debt was relatively small; and the Debtor filed the case on the “eve” of the potential termination of the PSA that would have resulted from its failure to close by Sept. 20, 2019. Notwithstanding indicia of bad faith, the Second Circuit has also observed that “there is a considerable gap between delaying creditors, even secured creditors, on the eve of foreclosure and the concept of the abuse of judicial purpose.” In re Cohoes Indus. Terminal, Inc., 931 F.2d at 228 Notably, here, the Debtor imminently filed a Chapter 11 plan identifying a clear, expedient path out of Chapter 11 (dependent upon exit financing) that would allow the Debtor to cure its defaults under the PSA and purchase the Property. The court found that the totality of the circumstances demonstrated that the Debtor appropriately invoked a protection provided for in the Bankruptcy Code to pay creditors and reorganize by ownership of the Property. The court reasoned: 

[T]he Debtor in this case is in financial distress; it did not have the funds to close on the Closing Date or pay its creditors and needed some more time.  If the Debtor does not purchase the Property pursuant to the Plan, it will be an empty shell with no money to pay anyone…. [T]he totality of the circumstances show that the Debtor has not filed its petition in bad faith but instead, has properly invoked a protection provided for in [section 108 of] the Bankruptcy Code to pay its creditors and reorganize through ownership of the Property. 

The Court observed that the Debtor needed to come up with $30 million to pay the Seller and its other creditors. It immediately filed a Chapter 11 plan that depended upon exit financing to do so. That plan would have paid all creditors in full. The Debtor had a lender lined up prepetition and the lender required more time to finalize the financing to close. The Debtor claimed that it had the financing which it would need to prove as part of the confirmation of the Chapter 11 plan to emerge. “Thus, the question comes down to confirmability of the plan, not bad faith.  Either the Debtor will have the money to close by the confirmation hearing (providing that the filing was objectively reasonable) or it will not (resulting in dismissal of the case).” And so, the court denied the Motion.

Why This Case Is Interesting

In real estate transactions, it is not unusual for parties to have TOE closing provisions. Nor it is unusual that despite a contract not being subject to a financing contingency, the buyer may require more time to secure its financing to close. These situations invariably lead to negotiations — much like what happened in AAGS Holdings — over fees and additional deposits for a consensual adjournment. Sellers may feel that they have the upper hand with an impending TOE closing and forfeiture of the deposits previously given by the buyer. And outside bankruptcy, such would be the expected negotiating leverage. Yet, bankruptcy should be the backdrop against which negotiations occur with the awareness of the potential ability of the buyer to obtain a nonconsensual extension (at least for 60 days) under the Bankruptcy Code. Nor is taking advantage of this Code’s extension period a per se act of “bad faith” — even for “single asset” cases. Courts look at the “totality of the circumstances” to assess a bad-faith filing and do not presume bad faith solely because a debtor filed a petition to benefit from a specific protection under the Bankruptcy Code — here, section 108. Likewise, the purchaser needs to weigh the cost of a bankruptcy against the benefits of getting additional time to close in the face of a potential forfeiture of the deposit and contract (not to mention that lenders can be finicky about lending to borrowers who have entered bankruptcy). In these negotiations, sellers should assess that fine line between receiving additional deposits and the buyer’s ability to provide these deposits against the bankruptcy backdrop. Cases can be distinguished by their facts. Here, the contract had clearly not terminated — automatically or otherwise —  prior to the filing, and the Debtor was able to propose a plan to emerge from bankruptcy with the exit financing within the 60-day period. As the court noted, the issues ultimately came down to whether the Debtor could proceed with its plan and close on the needed exit financing, which were plan confirmation issues.

Finally, you may wonder if the result would have differed if the PSA included an automatic termination provision. The court did not answer this, because the Seller needed to affirmatively give notice of its option to terminate the PSA. Therefore, the Debtor entered bankruptcy with a live PSA which the Seller could not then terminate because of the automatic stay. Moreover, the Debtor had the benefit of the entire closing day to file for bankruptcy. Would the result have been different if the PSA had an automatic termination provision and a clearly defined closing deadline? Time may tell. In any event, it does appear that sellers who do not want to lose the opportunity to enforce a TOE closing default would be wise to include in their PSAs an automatic termination provision and a specific time by which closing must be complete.