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December 8, 2022

Bankruptcy Basics for Retail Landlords

Issue 6—"Lease Disposition Options in Retail Bankruptcy Cases"

There are a number of options for the disposition of leases in retail bankruptcy cases. The debtor’s right to assume, reject, or assume and assign leases is generally central to the reorganization efforts of retail store chains. The basics of these types of lease dispositions are important to understand, though the facts and circumstances of each case may involve variations and more complicated structures.

Lease Rejection

If a debtor decides to reject a lease, the lease is deemed breached by the debtor immediately prior to the bankruptcy filing, the debtor must surrender possession of the leased premises, and the landlord may file a claim for damages resulting from the breach. The claim is typically unsecured except to the extent the landlord holds a security interest against the debtor’s assets or a security deposit. The debtor may reject any lease subject only to a “business judgment” standard of review by the bankruptcy court. Large retail store bankruptcy cases will often begin with one or more motions to reject a number of leases.

Lease Assumption: “As Is” (Cum Onere)

The debtor has the right to assume any lease, however, unless otherwise agreed to by the landlord, any lease assumption is subject to all of the terms, conditions, burdens, and benefits of the lease (sometimes referred to by the Latin phrase cum onere). Lease assumption also requires the debtor to provide adequate assurance that all defaults under a lease will be promptly cured following lease assumption. Generally, this means paying all rent defaults at or soon after lease assumption and curing any other nonmonetary defaults within the cure periods prescribed in the lease.

Lease Assumption: Negotiated

Much more commonly than cum onere lease assumptions, a debtor will approach its landlords, often through specialized real estate consultants, to negotiate the terms and conditions under which the debtor would be willing to assume the lease. These negotiations may result in a lease amendment that, subject to bankruptcy court approval, addresses the amount the debtor will pay to cure existing defaults, reductions to rent, extensions (or reductions) to the lease term, and even adding a landlord or mutual early termination right.

Lease Assumption and Assignment

Subject to many safeguards in favor of landlords—especially landlords of premises located in shopping centers—a debtor may seek court approval to assume and assign a lease to a third party. The Bankruptcy Code permits lease assignments notwithstanding assignment prohibitions or conditions in leases, but generally speaking, all other lease provisions must be adhered to. With respect to the assignment of shopping center leases, the Bankruptcy Code specifically mandates compliance with many common retail store lease provisions, such as use clauses and radius restrictions. One exception, however, is that any specific trade name required under the lease does not have to be used by the assignee. Additionally, any lease assignee must provide adequate assurance of future performance of the lease terms—this requires a showing as to the financial condition and operating performance of the assignee and may provide support for requiring a security deposit or guaranty as security for performance under the lease. In order to assign a lease, the debtor must first assume the lease, and thus, all requirements of lease assumption must also be met.

Lease Termination Agreements

Debtors and landlords may also agree to terminate a lease, which could involve consideration ranging from the landlord merely waiving some or all of its claims to the landlord paying a considerable sum to regain control of the premises.  

Lease Expiration

If a lease expires during the bankruptcy case and the debtor does not surrender possession of the premises, there is an applicable exception to the automatic stay that permits the landlord to proceed in state court to secure possession of the premises without further order of the bankruptcy court. However, the automatic stay will still be in place with regard to any of the debtor’s property at the premises absent further order.

Lease dispositions will vary based on the type and location of real estate, the terms of the leases at issue, the tenant’s business, and even the state of the economy during the bankruptcy case. Long-term real estate leases that rarely become available may be the most valuable assets in some cases, whereas many small shop leases require significant concessions by the landlord to avoid lease rejection. The foregoing broad summary of some of the most common retail bankruptcy case lease dispositions should inform your general expectations and strategy, but specific factors will be most determinative.

Now that we’ve covered lease disposition options, be on the lookout for the last Bankruptcy Basics issue of 2022, which will cover lease decision timing. As certain Bankruptcy Code amendments are scheduled to expire in late December, this is the perfect time to learn more and prepare yourself for what’s to come.
 

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