Virtual Symposium, Part VIII: Jonathan Lipson, Part II: Standstill Agreements

CONTRACTING COVID: PRIVATE ORDER AND PUBLIC GOOD
JONATHAN C. LIPSON*

Part II: Standstill/Tolling Agreements

Like the health-safety standards discussed in Part I of this post, the economic shutdown in the wake of the pandemic has been dominated by public institutional responses, including bailouts, bankruptcy, and litigation.  While all three are inevitable, they are also problematic.  Like health-safety standards, bailouts are politically fraught, leading to uncertainty about what sort of support we can expect from the government—when and how it will be doled out.  At the same time, courts may lack the resources and power to address a state of the world in which all or most contracts are suddenly in breach. 

A court may, for example, conclude that a loan agreement or lease is in default because the borrower or tenant did not pay. But so what?  Putting to one side temporary stays of residential evictions, how valuable is a judgment against a borrower or tenant who may be unable to pay due to the pandemic?  If the judgment debtor has valuable assets, it may hide them or seek protection in a chapter 11 bankruptcy court, in which case the judgement will have little practical value.

Here, too, contract can provide a potentially sensible solution through a standstill/tolling agreement.  Under a model that I (along with Norman Powell) recently published with the American Bar Association (ABA), the creditor agrees to take no “legal action” during the agreed standstill period, which would include commencing a law suit or exercising self-help rights, while the debtor agrees not to sell its assets outside the ordinary course of business or otherwise fundamentally change its structure so as to disturb the creditor’s basic expectations. 

In all but a small number of cases, standstills are likely to be better for the parties than any form of judicial intervention, whether bankruptcy or litigation, and may provide stability needed to take advantage of bailouts.  Bankruptcy is likely to be costly in terms of professional fees and managerial energy, and may deprive the debtor of control.  Litigation over contract disputes is likely to kill most relationships.  In either case, the parties will be faced with difficult decisions, such as whether to switch to other contract counterparts or simply to do without.  Switching costs are often high, and the uncertainties of the pandemic would seem to exacerbate that.  Establishing new relationships during COVID may be fraught because the parties may have had little pre-pandemic experience with one another, and little reference for how to assess performance going forward, due to the inherent uncertainty of the situation.

At the same time, standstills may support efforts to obtain new financing, whether from the government or privately.  Under the Paycheck Protection Program, for example, the Small Business Administration has concluded that it will not approve lending to companies in chapter 11 reorganization, and significant litigation may pose even greater risks to private lenders.  This means that staying out of court (bankruptcy courts or otherwise) may be better for all concerned, if at all possible. In any case, it will almost certainly be better for a firm to tell a new investor or lender that it is not currently fighting with its major contract counterparts.  The fact that it is has entered into a standstill may signal to new sources of capital a collaborative capacity and cautious optimism. 

Moreover, because the economy appears to have been largely healthy prior to the shutdown, there is reason to think that the economy could rebound rapidly when an effective vaccine becomes widely available.  This is hardly irrational exuberance: it appears to have happened in the wake of the 1918-19 pandemic.  While it will take an amount of time that is difficult to determine, the risk of missing gain coming out of the crisis may be just as significant as the risk of loss going into it.

Like health-safety precautions, standstills can also have important network effects.  The bank and borrower that agree to a standstill may enable the borrower to make partial payments to other, more fragile suppliers, thereby helping to keep all afloat.  Temporarily halting precipitous action at one link in a chain may help to keep the chain together long enough to get through the pandemic.

As with health-safety precautions, a key doctrinal question about standstill agreements is whether they violate public policy.  They will generally be enforceable if they do not harm the larger collective.  Courts may not enforce a standstill to prevent a voluntary bankruptcy commenced by the debtor, for example, because the process has implications for all of the debtor’s creditors, and not just the counterparty (e.g., creditor) to the standstill.  But, that same creditor may be able to assert rights under the standstill to lift the automatic stay and to seize collateral, an outcome the debtor may wish to avoid.

As with health-safety terms, standstills are hardly perfect mechanisms.  In the absence of good faith (or at least mutual assured destruction), there may be little appetite to forebear.   The benefits of forbearance may be hard to explain to an angry client who has not been paid by her debtor, yet is being dunned her creditors. 

Yet, this may be one of the more important, if subtle, benefits of a standstill: it enables the parties to focus on a concrete set of comparatively constructive steps in a moment when there is otherwise so much uncertainty in the world.  Even if the standstill fails to bridge the gap to a renewed relationship, a timeout of short and negotiated duration can buy parties the opportunity to peer around an uncertain corner together, in order to make better collective decisions. At some point the hammer may fall, of course, and parties may have to make more drastic choices.  But in the near term, agreeing neither to agree nor disagree may be the best most parties can hope for.

Conclusion

We generally consider contract the domain of private and pecuniary order: voluntary exchange will tend to make more of us richer more of the time.  While that may be true enough, moments like COVID suggest that this only part of the story.  Private ordering through contract can and should also contribute to public good.

*Earlier versions of this essay or aspects of it were presented to the National Business Law Scholars Plenary, the Business Law Section of the American Bar Association, the Fellows of the American College of Commercial Finance Lawyers, the Association of Commercial Finance. Errors and omissions are mine, alone.  © 2020, Jonathan C. Lipson, all rights reserved.