By Jeff Montgomery

Law360 (July 14, 2020, 7:20 PM EDT) -- Already facing a revolt from landlords who haven't been paid for months, bankrupt 24 Hour Fitness Worldwide Inc. confronted court questions about new risks of insolvency Tuesday after the return of COVID-19 business shutdowns in California jeopardized the debtor's Delaware Chapter 11 budget and delayed action on a $250 million case loan.

Ryan Preston Dahl of Weil Gotshal & Manges LLP, counsel to 24 Hour Fitness, told U.S. Bankruptcy Judge Karen B. Owens that the California order forced 151 of 158 centers in that state to close.

"Taking into account these closures, the debtors now have 102 clubs open nationwide as of this moment. We cannot say with certainty, as we sit here today, whether these closures will continue for the long term," Dahl said. By comparison, the company was operating 445 clubs — all leased — with 3.4 million members across the country before the COVID-19 pandemic forced a closing of all sites nationwide on March 16.

Reports on the closings and resulting revenue losses, and concerns that others could follow in Texas, Florida and elsewhere, were followed by objections from landlords seeking clearer assurances of their eventual payment — even if it required concessions from creditors and DIP lenders reluctant to take further risks.

"What I want to know is, if you eliminate all of your revenue from your stores, essentially assume a complete rollback of your operations, and putting aside professional fees, I just want a yes or no on whether all of the disbursements in the budget will be able to hypothetically be paid, or would you be insolvent?" Judge Owens asked. 

Dahl said the debtors could run out of cash before the 13-week case budget ends if all revenues dry up.

"To the extent you feel we should have an evidentiary hearing to address my concerns with respect to the budget and the shifting landscape, we have time for that," Judge Owens said later. "I'm not foreclosing from putting on evidence and allaying my concerns with respect to solvency."

The session was originally convened to secure final approval of a $250 million debtor-in-possession bankruptcy funding loan and $250 million refinancing of prepetition secured debt.

It pivoted to talks on compromises with landlords and solvency after the judge said she was unprepared to include in the DIP order waivers of the debtor's right to tap secured creditor collateral or security interests to cover some estate costs.

"If you're not getting any revenue from your stores, are you still able to hypothetically fund all the post petition obligations to your landlords, whether its closed stores or open stores?" Judge Owens asked Dahl. "What is the certainty of payment with respect to this budget?"

Ivan M. Gold of Allen Matkins Leck Gamble Mallory & Natsis LLP, counsel to a large group of landlords — including many in California — told Judge Owens that the change in the business and bankruptcy landscape after California's shut-down order on Monday was "tectonic," with the consequences for 24 Hour's Chapter 11 unclear.

"Your honor's concerns about the future of this case and administrative insolvency are real," Gold said, adding that a settlement agreement between the DIP lenders, unsecured creditors and 24 Hour "places enormous stress and risk on the landlord community."

Several compromises to the DIP agreement were filed on Monday ahead of the hearing to address objections from unsecured creditors. That group withdrew its objection despite noting that it secured only some of its objectives. Unpaid leaseholders, meanwhile, argued for more protections and urged the court not to approve a plan that cut off their rights.

Gold said that debtor estimates of rent obligations have declined from $32 million to $25 million, although the actual number could be as high as $75 million. He also urged the judge to consider continuing the debtor in possession loan on a second interim, rather than final, basis, while also not limiting the options of the debtor, such as a creditor-preferred waiver of the debtor's ability to seek access to cash ordinarily secured for creditors if needed for the case.

Among things landlords asked for on Tuesday included assurances that they will be treated on the same footing as other administrative expense creditors, and that 24 Hour will pay post-petition rents and comply with requirements for accepting or rejecting leases.

"The problem here is, we have no idea — forget about September — we don't know what the world is going to look like on August first," said Leslie C. Heilman of Ballard Spahr LLP, counsel to several landlords. "The problem really is, so many locations are closed even as of yesterday. There should be absolutely no way that there is a pre-judgment now that the debtors can continue to not reject a lease just because a club is closed."

Judge Owens asked the debtors, lenders, unsecured creditors and landlords to discuss options, with another hearing scheduled for Wednesday.

"Eventually this is going to have to come to a head," the judge said. "At what point do the landlords have to stop shouldering the optionality you and the debtors are gaining by not rejecting the leases?"

24 Hour is represented by Laura Davis Jones, Timothy P. Cairns and Peter J. Keane of Pachulski Stang Ziehl & Jones LLP, and Ray C. Schrock, Ryan Preston Dahl and Kevin Bostel of Weil Gotshal & Manges LLP.

The ad hoc group of lenders is represented by Mark D. Collins, Michael J. Merchant and David T. Queroli of Richards Layton & Finger PA, and John J. Rapisardi, Adam C. Rogoff and Daniel S. Shamah of O'Melveny & Myers LLP.

Morgan Stanley Senior Funding Inc., as lender administrative and collateral agent, is represnted by Andrew L. Magaziner of Young Conaway Stargatt & Taylor LLP, and Richard A. Levy and James Ktsanes of Latham & Watkins LLP.

The case is 24 Hour Fitness Worldwide Inc. et. al., case number 20-11558, in the U.S. Bankruptcy Court for the District of Delaware.

--Editing by Adam LoBelia.

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