Toys “R” Us has offered certain of its landlords an unprecedented payment package in exchange for more time to decide which leases it will keep and which it will dispose of in its chapter 11 bankruptcy case. The package includes payment of “additional rent,” including common-area maintenance, insurance, and real estate tax arrearages under rejected leases, amounts that ordinarily would not be paid in full. The deal may serve as a model for the treatment of landlords in future large retail bankruptcy cases.
When a debtor is a tenant under an unexpired lease of nonresidential real property, federal bankruptcy law provides the debtor-tenant with the option of assuming the lease (i.e., agreeing to perform under it going forward during its bankruptcy and thereafter) or rejecting the lease (i.e., breaching it by disavowing its obligations to perform under it). The debtor-tenant has 120 days after filing its chapter 11 bankruptcy case to assume a lease; otherwise the lease is deemed rejected. Debtors may ask the court for one 90-day extension of this time period; any further extensions require written consent of the landlord. To obtain this consent, landlords may bargain for accommodations, such as confirmation from a debtor that it will remain open and operating in the space and paying rent through some date certain.
Further, if the debtor ultimately decides to assume the lease, it must “cure” any pre-bankruptcy default, including payment of past due rent and “additional rent.” On the other hand, if the lease is ultimately rejected, the pre-bankruptcy defaults are merely included in the landlord’s general claim against the debtor, which may be paid pennies on the dollar. Thus, it is unusual for a debtor to offer landlords payment towards their pre-petition debt before the debtor has decided whether to assume the lease or not – but that’s just what Toys “R” Us did here!
Absent landlord consent, Toys “R” Us would have had to evaluate and elect to assume or reject almost 800 U.S. store leases by April 16, 2018. To gain additional time to develop a viable business plan, Toys “R” Us gained court approval to offer the following package of consideration in exchange for each landlord’s consent to extending that election period through the date of confirmation of a plan of reorganization:
- Toys “R” Us will allocate $1.3 million to pay: (i) attorneys’ fees incurred by the consenting landlord in connection with review of the terms of the extension, and (ii) pre-petition “additional rent” claims (including CAM, insurance, and real estate taxes) of landlords who consent to extensions and whose leases are ultimately rejected;
- Toys “R” Us will waive all rights to claw-back “preference payments” made by Toys “R” Us to consenting landlords in the 90 days before the bankruptcy case was filed; and
- If Toys “R” Us does not reject a lease and surrender possession of the premises by August 31, 2018, they will not reject the lease until, at the earliest, January 4, 2019 – thereby assuring those landlords that they will not have large, dark store spaces during the back-to-school and winter holiday seasons.
This consideration package is unusually favorable to landlords. First, a landlord’s attorneys’ fees are usually reimbursable only if the debtor assumes the lease and the fees are allowed under the lease. Here, attorneys’ fees will be paid to all landlords that consent, regardless of how the debtor elects to treat the lease and whether the lease allows for reimbursement of such fees. Second, pre-petition arrearages, such as “additional rent” (e.g., CAM, insurance, real estate taxes) are typically only paid when a lease is assumed (as part of the required “cure” payment), whereas for rejected leases, those amounts are added to the landlord’s bankruptcy claim, which often receives pennies on the dollar. Here, Toys “R” Us will pay in full at least some pre-petition “additional rent” amounts for landlords whose leases are ultimately rejected, thereby treating them better than non-consenting landlords whose leases are rejected.
The consent requirement for extension of the election period on leases provides landlords with significant bargaining leverage. The Toys “R” Us case should encourage landlords to exercise that leverage by negotiating for anything they deem important or desirable, including payment of pre-petition arrearages.