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February 9, 2023

Bankruptcy Basics for Retail Landlords

Issue 10—"Retail Real Property Leases – Assumptions/Assignments: Adequate Assurance"

Our recent issues addressed the debtor-tenant’s: options for its retail leases, time frame for exercising those options, duty to perform its leasehold obligations in a timely manner, and obligation to cure defaults to assume or to assume and assign leases. In this issue, we’ll cover the “adequate assurance of future performance” requirement in connection with the debtor’s assumption or assumption and assignment of leases.

Adequate Assurance Requirement for Lease Assumptions and Assumption/Assignments

If there are any defaults under a lease that the debtor wishes to assume, the debtor must promptly cure the defaults and prove that there exists adequate assurance of future performance of its leasehold obligations. If there are no defaults, the debtor need not prove adequate assurance to assume the lease. In contrast, in order to assume and assign a lease, the debtor must demonstrate adequate assurance of future performance of leasehold obligations by the assignee regardless of whether the lease is in default. Landlords cannot rely on lease provisions restricting or prohibiting lease assignments, as the Bankruptcy Code generally renders those provisions unenforceable. However, subject to Bankruptcy Court approval, landlords can require a deposit or other security, such as a guaranty or letter of credit from the proposed assignee, substantially the same as the landlord would have required from a similar tenant at the time of the lease.

Heightened Adequate Assurance Requirements for Shopping Center Leases

The Bankruptcy Code imposes additional requirements for adequate assurance of future performance under leases of property in shopping centers. These include adequate assurance of the source of rent, that percentage rent will not substantially decline, that the assignee will be subject to all terms of the lease and will not breach provisions in other leases (such as other tenant exclusives), and that the assignee will not disrupt the tenant mix or balance in the shopping center. Importantly, the debtor must show that the financial condition and operating performance of the proposed assignee is similar to that of the debtor as of the commencement of the lease. Adequate assurance of future performance thus operates to preserve the core benefits of the landlord’s bargained-for lease provisions despite the unenforceability of anti-assignment lease provisions.

Practical Considerations

A debtor-tenant marketing some or all of its leases will often ask the Bankruptcy Court to approve a two-step process: first, it will request court approval of procedures and a timeline for bidding, an auction, fixing cure amounts, and, finally, a hearing to consider approval of lease assignments. Landlords must closely review the proposed lease marketing procedures and seek to obtain adequate assurance of future performance information from potential assignees as early as possible. Specific adequate assurance information should be required from bidders when bids are submitted, and that information should then be disseminated to landlords promptly and well in advance of the deadline to object to lease assignments. The adequate assurance information generally should include the identity of proposed assignees and any guarantors, their financial statements, projections, tax returns, business plan, experience with operating stores in shopping centers, identity of management, and a contact person to answer more specific questions.

Debtors often propose a compressed time frame from when bids for leases are due through the hearing to consider approval of lease assignments. This frequently includes a request that the hearing on lease assignments be held as early as the day after the auction, when landlords may not even know the identity of the proposed assignee(s) of their leases. Landlords should be prepared to react quickly and object to procedures that do not afford sufficient due process. 

The next issue of Bankruptcy Basics will continue the lease assumption topic by covering the negotiation of lease amendments during a retail bankruptcy case.
 

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