The last several years have been treacherous for the retail sector. Changing shopping patterns and shifting demographics have led some commentators to declare that the (retail) apocalypse is upon us. And while we have seen numerous mega-bankruptcies, including Sears, Toys ‘R Us, Borders, Payless Shoes and Radio Shack, other commentators describe this less as an apocalypse and more as an opportunity for re-rebirth.
Whichever view is correct, there can be no dispute that the bankruptcy process stands directly at the intersection of disruption and opportunity. With that in mind, it is worth taking a big-picture look at the chapter 11 bankruptcy process.
When a company files for bankruptcy, the immediate result is the imposition of what is known as the “automatic stay”. The automatic stay prevents creditors from taking or continuing enforcement actions or exercising remedies absent court approval. This gives the debtor a breathing spell to decide the best path forward.
During the first 210 days of the bankruptcy case (which period may only be extended with the landlord’s consent), the debtor has the right to decide whether it wants to assume, assume and assign, or reject its leases. The debtor can also sell its “designation rights” to a third party – giving the acquirer the right to decide which leases to reject, assume and or assign.
While the automatic stay prevents creditors from taking actions with regard to unpaid pre-petition amounts absent court approval – the debtor must pay its bills on a current basis during this post-petition period. (If it doesn’t keep current, then the landlord may apply to the bankruptcy court for relief from the automatic stay to exercise its remedies.)
Landlords may be surprised to hear that anti-assignment provisions in their leases are typically unenforceable in bankruptcy. The debtor can assign its lease over the objection of the landlord – so long as it first cures all monetary (and other curable) defaults under the lease, and also provides adequate assurance of the assignee’s ability to perform under the lease going forward. In the shopping center context, adequate assurance includes compliance with lease provisions regarding radius, location, use, exclusivity, and tenant mix. The landlord may also require a deposit or other security for the performance of the debtor’s obligations under the lease substantially the same as would have been required by the landlord upon the initial leasing to a similar tenant.
After analyzing its options, the debtor may attempt (i) to reorganize (often through a debt-for-equity swap and an infusion of new cash), (ii) to sell some or all of its assets (such as its intellectual property, inventory or valuable locations), or (iii) to liquidate. In some instances, the chapter 11 process will include aspects of each of these options – permitting the debtor to rid itself of costly leases, unprofitable contracts and non-core business lines, while reorganizing around a smaller foot-print of profitable stores.
While debtors – at least initially – have the ability to decide the direction of the bankruptcy case, landlords should be aware that they have the opportunity to participate in the process. Landlords must remain vigilant to protect their rights during the bankruptcy, including pursuing claims for amounts owed, and monitoring the case to make sure the debtor does not pledge its leasehold rights to its post-petition lenders or attempt to cherry-pick the valuable parts of its leases while leaving behind burdensome provisions. Additionally, landlords can engage with debtors to encourage them to expedite assume/reject decisions. Landlords can also negotiate partial surrenders and modifications with debtors – and in some instances may even be able to bid to take back their leases.
Bankruptcy is not always a tidy process – but it is also not the end of the story. While mall operators may need to deal with the loss of long-term tenants, that loss also presents opportunities to increase foot traffic by modernizing tired spaces and bringing in new, healthy tenants ready to meet the needs of today’s consumers.