PRINCETON, NJ—Chapter 11 bankruptcy filings are afoot in the retail sector and are expected to continue for the next few years, but vacancies can provide opportunities for the use of rental space. Sports Authority, PacSun, Aeropostale, EMS and Fairway Market are just a few recent examples of big retailers who have filed for Chapter 11 bankruptcy protection during the past year. Landlords can maximize value by understanding how to manage and leverage the lease in a bankruptcy.

Indicators of a bankruptcy filing are non-payment of rent, inventory pile-ups, missing key financing deadlines, and even failure to attend leasing meetings. Calling a default, and/or filing an eviction action may bring the lease current prior to a bankruptcy filing.

If you terminate a lease prior to bankruptcy, it is advisable to properly document the reasoning for the termination. Recently, actions were filed under Bankruptcy Code §§ 547(b) and 548(a)(1) in a case out of the Seventh Circuit, In re Great Lakes Quick Lube, Ltd., 528 B.R. 893 (E.D. Wis. 2015) to recover lost value of a lease. The court held that an action by the creditors' committee to find two profitable leases that were terminated pre-bankruptcy with three unprofitable leases could proceed as an avoidance action–meaning the creditor could have to give money back to the debtor for the value of the two profitable leases.

The case was remanded for the Bankruptcy Court to determine if there was any value in both of the leases, and whether there are any applicable defenses if there was value. The outcome is being closely watched, but in the interim you should be sure to document all lease terminations.

The initial filing includes the petition, schedules, and “First Day Orders,” such as use of cash collateral to get the debtor through the first few weeks. These documents provide a “tell” as to the direction of the case and treatment of claims.

Further, landlords hold leverage to object to the First Day Orders if the lease is not being abided. It is imperative to protect your rights by involving counsel early to provide a proper analysis and review.

Bankruptcy filings can be daunting because of the sheer volume of paperwork, but the case all comes down to what happens to the leases. Some will be sold to new entities with a similar name or auctioned and assigned to new tenants within the bankruptcy. Others will be rejected and turned back over to the landlord. Additionally, like in the Sports Authority case, the debtor may schedule an auction on multiple dates to maximize value for the estate.

Bankruptcy Code § 365(d)(4) provides a debtor 120 days to assume or reject a lease. If the lease is not assumed, it is deemed rejected. During this period, the debtor must abide by the terms of the lease, and any assignee takes the lease under its terms, unless modified by consent. In recent cases, like A&P and Sports Authority, debtors have requested modifications of over market leases. Prior to entry of any modification, bankruptcy counsel should review to ensure all rights are protected, such as voiding/expiration of the modification if there are no lease bidders.

Although the debtor has 120 days to decide whether to assume or reject a lease, it may request a 90-day extension, which most debtors seek due to the tight schedule. Landlords should ensure that not only are they are being kept current, but also that the debtor provides a budget to show they will keep the landlord current during the next 90 days.

Bankruptcy Code §§ 363 and 554 allows debtors to sell assets and abandon remaining assets, respectively. As part of any lease, the purchaser must take the lease subject to its terms, unless otherwise agreed. Adequate assurance packages are required prior to approval of any lease sale. At minimum, landlords should demand audited financials, corporate and trade names of the proposed bidder/ tenant that operate the store, intended use for the space, cash flow projections/recent business plan, and evidence of the proposed assignee's retail experience.

Review of the lease in bankruptcy and all other leases for the center is essential to ensure there is no breach in use restrictions. Often a bidder will agree to modify terms to ensure no default. Further, if the bidder's financial condition is not as viable as the debtor, requesting a guaranty by a parent or other entity may resolve the issue. For instance, in the Joyce Leslie case, when requested, many landlords whose leases were assigned to separate LLCs were provided a corporate guarantee by the parent.

A store closing motion provides a procedure for lease turnover. Communicating with operations personnel is important to address this motion. You can help avoid real issues like freezing or burst pipes by tracking information such as the last time your property manager spoke with the store manager to obtain security codes, HVAC and utility. Have counsel assert these operational issues so that if a store is rejected or abandoned, you're not scrabbling for that information after the fact.

Landlords hold a variety of claims in Chapter 11 bankruptcy cases, including: pre-petition claims for amounts owed as of the filing date; stub rent claims for amounts due to a landlord for the period of use and occupancy between the bankruptcy filing date and the first post-petition rent payment; post-petition administrative claims for amounts due and owing during the use; and post-petition rejection claims for damages and other charges after rejection. Proper assertion of these claims is essential to ensure preference on the payment schedule of the debtor's plan.

Nothing can prevent a debtor from filing bankruptcy, but landlords can mitigate against the risks by not only monitoring rent payments and other tell-tale signs of a possible filing, but also enforcing their rights to terminate or evict if such signs persist. Many of these retail bankruptcies present opportunities for landlords to tailor the vacancy to uses that can attract more consumers.

Thomas S. Onder is a Shareholder and member of the commercial, retail and industrial real estate, litigation and bankruptcy & creditors' rights groups of Stark & Stark. He may be contacted at (609) 219-7458 or tonder@Stark-Stark.com. The views expressed here are the author's own.

Bankruptcy filings can be daunting because of the sheer volume of paperwork, but the case all comes down to what happens to the leases. Some will be sold to new entities with a similar name or auctioned and assigned to new tenants within the bankruptcy. Others will be rejected and turned back over to the landlord. Additionally, like in the Sports Authority case, the debtor may schedule an auction on multiple dates to maximize value for the estate.

Instant Insights /

Landlord Issues, Opportunities in the Wave of Retail Chapter 11 Filings

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