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March 9, 2023

Bankruptcy Basics for Retail Landlords

Issue 12—"Retail Real Property Leases: Lease Rejections"

Among other options, retail tenants filing for bankruptcy generally have the ability to reject their unexpired store leases. Lease rejection is similar to termination and allows tenants to avoid performing their future lease obligations while leaving landlords with only general unsecured claims, which, as noted in earlier issues, generally will not have meaningful value. Landlords’ rejection claims are capped—which we’ll introduce below and explore in more detail in a later issue—but there are also potential pre-petition and administrative (post-petition) claims.

When tenants file a motion to reject one or more leases, they will generally propose a fixed rejection effective date. It’s important, however, for the rejection to be effective as of the later of a date certain and when the tenant turns over the premises by written notice while providing keys, key codes, and security codes to the landlord. Critically, any remaining personal property at the leased premises must be deemed abandoned, with the landlord able to dispose of it without liability. It’s also best practice to require the tenant to remove all hazardous materials and personally identifiable information (PII) prior to rejection. All of these measures—which should be memorialized in a Bankruptcy Court order—are meant to ensure the landlord has full dominion and control of the leased premises upon rejection, which is also when the tenant may no longer have an insurable interest under the lease

In larger retail cases, tenants often file a motion to establish procedures to be followed for all lease rejections to streamline the process going forward. Lease rejection motions or notices are not the final word, however. The tenant may withdraw the proposed rejection as to certain leases if, for example, last-minute agreements are reached with landlords for the tenant’s assumption of the leases. Given this dynamic, lease rejections may be used tactically by retail tenants to elicit better terms from a landlord. If the lease does end up getting rejected, the landlord is entitled to file claims for: (a) the pre-bankruptcy amounts owed under the lease and (b) the damages caused by the lease rejection. The rejection damages portion of the claim is capped at the “rent reserved” for the greater of (i) one year or (ii) 15 percent of the remaining lease term, not to exceed three years. The rejection damages cap is designed to approximate the landlord’s actual damages from the rejection of the lease in light of the expected eventual reletting of the premises and to prevent landlords from holding an outsized portion of the claims against the tenant given the typically lengthy term of commercial leases. There are often open questions as to what constitutes “rent reserved” and how lease obligations are calculated under the cap, which are outside of the scope of this issue.

Prior to a lease being rejected, the tenant often runs a store closing or inventory liquidation sale at the store, which Bankruptcy Courts almost always permit despite many leases conditioning or prohibiting these types of sales. The conduct of these sales in retail bankruptcy cases—including what landlords can do to protect the premises—will be covered in the next issue of Bankruptcy Basics for Retail Landlords.

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