Key Considerations for Commercial Landlords When Faced With a Tenant’s Bankruptcy
By Jill L. Murch
Perhaps one of the most dreaded words in a commercial landlord’s lexicon is “bankruptcy.” Indeed, a tenant’s bankruptcy can present pitfalls for an unwary landlord. Upon a tenant’s bankruptcy, myriad rules and provisions spring into effect, often curtailing a landlord’s rights under the underlying lease. This article highlights certain key considerations for a commercial landlord when faced with a tenant’s bankruptcy.
The Automatic Stay
Upon the tenant’s bankruptcy, the landlord is no longer free to exert unilateral control over the tenant’s leasehold interest — even if such action is contractually bargained for under the lease. Instead, the United States Bankruptcy Code’s (Bankruptcy Code) automatic stay prevents, inter alia, actions by a landlord to obtain possession or exercise control over property of the estate.1 In other words, the automatic stay is a sweeping injunction that prevents creditors from dissipating or diverting assets of the estate. This includes actions that may be taken by commercial landlords. Before a landlord may take action against the debtor and its property, the landlord must first seek relief from the bankruptcy court to lift the automatic stay. Unwitting landlords who fail to obtain such permission will find themselves in violation of the stay, rendering their actions either void or voidable.2
Ipso Facto Clauses
Although pervasive in commercial leases, ipso facto clauses (clauses “by which a contract is terminated as a result solely of the debtor’s insolvency or bankruptcy”) will not be given effect in bankruptcy since they are viewed as hampering a tenant’s ability to reorganize.3 Indeed, such clauses provide little solace to landlords within the confines of a bankruptcy case.
Assumption and Rejection of Commercial Leases
The Bankruptcy Code grants a tenant the earlier of 120 days after the entry of the order of relief4 or the date of the entry of an order confirming the debtor’s bankruptcy plan to decide whether it will continue to be bound by the lease, i.e., assume the lease, or whether it will reject the lease.5 If the debtor fails to assume the lease within this period, the lease is automatically deemed rejected.6 Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) on October 17, 2005, a debtor could make multiple requests to the bankruptcy court to extend the time to assume or reject a lease as long as the debtor demonstrated “cause.”
However, the BAPCPA has significantly bolstered landlords’ rights by capping such extensions. Under the BAPCPA, a debtor may, prior to the expiration of the 120-day period, request that the bankruptcy court extend this period for up to an additional 90 days upon a showing of cause.7 Any subsequent extensions may only be upon the prior written consent of the landlord.8 As a result, a tenant now only has 210 days after filing for bankruptcy to decide whether it will assume or reject its lease, absent a landlord’s consent. This limitation is particularly relevant to large commercial retailers with multiple leases, who are now required to strategically evaluate their leases well in advance of a bankruptcy filing.9
If a tenant opts to assume the lease, it must: (1) cure or provide adequate assurance that it will cure defaults under the lease, including defaults related to non-monetary obligations under the lease; (2) compensate or provide adequate assurance that it will compensate the landlord for any actual pecuniary loss to the landlord resulting from the defaults; and (3) provide adequate assurance of future performance under the lease.
If the tenant rejects the lease, the landlord is left with a general unsecured claim for damages, subject to a cap.10 The cap limits the landlord’s damages claim to the following:
(A) The rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease, following the earlier of:
(i) The date of the filing of the petition; and
(ii) The date on which such landlord repossessed, or the tenant surrendered, the leased property; plus
(B) Any unpaid rent due under such lease, without acceleration, on the earlier of such dates.11
For example, for any lease term with 20 years or more remaining, the cap will be three years’ rent. If the remaining lease term were 10 years, the cap would be 18 months’ rent.
Assignment of Commercial Leases to Third Parties by the Tenant
Commercial landlords often engage in rigorous screening of commercial tenants. However, the happenstance of a tenant’s bankruptcy could result in a landlord being left with an entirely new tenant without ever consenting to such assignment. The Bankruptcy Code permits a tenant to assign its lease to any third party so long as (1) the tenant takes all steps necessary to assume the lease and (2) the assignee provides adequate assurance of future performance regardless of whether or not there is a default. Significant incentive exists for a tenant to assign the lease where the commercial space is in high demand. For example, a tenant may currently be paying the landlord $10,000 a month for commercial space. The tenant files for bankruptcy and assigns the lease to a third-party for $15,000. The tenant — not the landlord — captures the $5,000 a month profit, regardless of the terms of the lease.
Conclusion
Even the most diligent of commercial landlords may find themselves in the throes of bankruptcy. While this article provides a general outline of some of the key issues facing commercial landlords, other specific considerations exist, including possible pre-bankruptcy termination of the lease and related remedies a debtor may seek against the landlord for such termination, including the recovery of alleged fraudulent transfers and/or preferences; the possible setoff of security deposits; and whether leases are considered disguised financing agreements to name just a few. As such, it is recommended that any landlord who suspects a tenant may be filing for bankruptcy consult with a legal professional to plot a proper and comprehensive course of action.
Foley Attorneys Receive Vision Award for Urban Redevelopment Efforts
Foley’s Milwaukee office recently received the Vision Award at the 8th Annual Milwaukee Awards for Neighborhood Development Innovation (MANDI), presented by the Local Initiatives Support Corporation (LISC).
LISC is the largest nonprofit in the country dedicated to urban redevelopment. Each year, the organization presents the MANDI awards to honor nonprofit community groups and their partners involved in revitalizing Milwaukee neighborhoods. The Vision Award specifically recognizes a group that has shown strong commitment and leadership in transforming the community through financial contributions or in-kind support to local development efforts.
Foley was honored for dedicating pro bono hours to complex projects in the community, including redevelopment of the Menomonee Valley, a 1,200-acre brownfield located adjacent to downtown Milwaukee; assistance to the 30th Street Industrial Corridor; completion of the Hank Aaron State Trail, which links the Milwaukee lakefront with the near west side of the city; and development of the new Discovery World at Pier Wisconsin.
Foley attorneys Michael W. Hatch, Hugh J. O’Halloran, Bruce A. Keyes, Sarah A. Slack, and David M. Loringwere honored at the award ceremony.
The firm also was recognized for its adoption of a firm-wide policy to support and encourage pro bono work. In 2005, the firm logged more than 30,845 pro bono hours, more than doubling its 2003 total.
American Girl Relocating to Chicago’s Water Tower Place
By Donna J. Pugh
American Girl, one of the nation’s top direct marketers, children’s publishers, and experiential retailers is moving its renowned American Girl Place flagship store to Water Tower Place, widely recognized as one of the premier shopping destinations in the world and one of the foremost tourist attractions in the city of Chicago. Water Tower Place is owned and managed by General Growth Properties, the nation’s second largest mall owner/operator with over 200 regional shopping malls totaling over 200,000 million square feet of retail space. The move to Water Tower Place provides American Girl with opportunities for growth such as offering a fun new experience for girls, expanding the Cafe to include a private dining area, and, ultimately, serving more customers. The size and layout of the new store also will provide a more efficient store layout with additional entrances, underground parking access, and increased street-level visibility, contributing to a more pleasant shopping experience for customers.
Donna Pugh, who leads Foley’s National Land Use and Entitlements Sub-Group as a part of the Real Estate Practice and her land use team, assisted American Girl and General Growth Properties in obtaining necessary governmental approvals to accommodate American Girl’s signature berry awnings and other needed physical changes. Foley lawyers, Blaine R. Renfert, Elizabeth L. Corey, Michael G. Laskis, Michael B. Van Sicklen, Christopher C. Cain, and Mark J. Diliberti have provided legal services to American Girl in the past in the areas of leasing, litigation, corporate, and intellectual property. In addition, Mark Mansour and Sara A. Key represent Mattel, American Girl’s parent company in regulatory and public policy work.
Since the first catalogue debuted in 1986, American Girl has devoted its entire business to celebrating girls ages three to 12 through an array of premium-quality books, dolls, clothes, toys, and accessories. Today, American Girl is a wholly-owned subsidiary of Mattel, Inc., the world’s leading toy company as well as one of the country’s most respected brands.
In 1998, the company opened American Girl Place Chicago — a retail and entertainment site located in the Gold Coast shopping district off of Michigan Avenue — as a way to bring its products and stories and the values they represent together in one special place. From the moment the doors opened, American Girl Place Chicago has been praised as one of the premier models for experiential retail in the country. Almost overnight, the store’s signature berry-colored shopping bags flooded Michigan Avenue as well as city hotels, buses, and trains and today are a widely recognizable Chicago icon. The success of the Chicago location paved the way for two additional American Girl Place flagship locations. American Girl Place New York opened in 2003 along Manhattan’s legendary Fifth Avenue, and American Girl Place Los Angeles opened in 2006 at The Grove, L.A.’s renowned outdoor shopping and entertainment destination.
Since purchasing Water Tower Place, General Growth has worked diligently to enhance the retail mix and has added over 80,000 square feet of new and existing retail concepts, many of which have entered the Chicago market for the first time, adding an element of uniqueness and creating a special shopping experience for Chicago shoppers.
The move to Water Tower Place has been met with enthusiastic support from the Greater North Michigan Avenue Association, Streeterville Organization of Active Residents, and local residents at a series of public presentations and community meetings. The store is anticipated to open in fall of 2008. We look forward to seeing the berry-colored bags and awnings gracing Water Tower Place on Michigan Avenue.
2 11 U.S.C. § 365(d). Section 365(d) permits a landlord to lift the injunction imposed by the stay by demonstrating that “cause” exists (including a lack of adequate protection) or that the tenant lacks equity in the property and the property is not necessary for to an effective reorganization.
3 See, e.g., EBC I, Inc. v. America Online, Inc., 03-50003, 2006 WL 3525031, at *7 (Bankr. D. Del. Dec. 7, 2006); 11 U.S.C. § 365(e)(1).
4 Note that the order for relief is self-executing and is deemed entered on the date the debtor files its bankruptcy petition in a voluntary bankruptcy case. However, in an involuntary bankruptcy case, the petition date and the date of the order of relief may not be the same.
5 During the period between the tenant’s bankruptcy filing and its determination whether to assume or reject its lease, the tenant must continue to perform its obligations under the lease. 11 U.S.C. § 365(d)(3). In other words, although the tenant is not required to pay pre-petition rent, the tenant must make post-petition rent payments. The bankruptcy court may extend the time for the tenant’s post-petition performance to 60 days after the entry of the order of relief.
9 One may ask why a debtor would not simply assume the lease before the 120-day deadline and then later reject the lease if it finds the lease to be cumbersome. The reason is that if a lease is both assumed and rejected post-petition, such post-petition damages are elevated from a general unsecured claim to an administrative expense claim in the bankruptcy. In re Multech Corp., 47 B.R. 747, 750 (Bankr. Iowa 1985); 11 U.S.C. § 365(g)(2). The landlord’s administrative claim must be paid in full before a tenant can confirm its proposed Chapter 11 plan. 11 U.S.C. § 1129(a)(9).