Thursday, October 24, 201911:00 AM – 12:15 PM

Seminar 13

The Nuts & Bolts of a Retail Bankruptcy: What Landlords Need to Know to Protect Their Rights and Avoid

Pitfalls

Brian A. AudettePerkins Coie LLP

Chicago, IL

Vanessa P. MoodyGoulston & Storrs

Boston, MA

Bankruptcy Rumors Are Swirling – What to Expect/What Can I Do??

• Real Estate Consultants – What to expect when you get the call.

• The Pros and Cons of:o Lease Termination, ando Accelerated Rental Payments

My Tenant Stopped Paying Rent and Filed for Bankruptcy and I’m Angry!?!?!

1. I am going to terminate the lease!!• after all, the lease expressly provides that a bankruptcy filing is a default

2. I am going to sue them for damages!!• after I apply their security deposit to unpaid rent

3. I am going to sue to evict them from my shopping center!!• they have no right to possession after I terminate the lease

4. Counsel, what else can I do to inflict pain upon my tenant?!?!?

Not so fast, my friend--there is an automatic stay!

What is the “Automatic Stay” and What Actions Does it Prohibit?

1. The stay applies “automatically” when a debtor files its bankruptcy petition and remains in effect until the end of the case or until the stay is lifted.

2. Stops most actions against the debtor to provide “breathing room.” Specific prohibited acts are set forth in section 362(a)(1)-(8), including, but not limited to:

a) The commencement or continuation of any judicial, administrative, or other action or proceeding against the debtor;

b) Enforcement of a judgment obtained before the bankruptcy case;

c) Any act to obtain possession of property of the estate;

d) Create, perfect or enforce a lien against property of the estate;

e) Create, perfect or enforce against a debtor’s property any lien that secures a claim arising before the bankruptcy filing;

f) Collect, assess, or recover a claim against the debtor that arose before the bankruptcy filing; and

g) Setoff any debt owing to the debtor that arose before the commencement of the bankruptcy case against a claim against the debtor.

3. Be careful! You can be subject to sanctions if a Court determines that you willfully violated the automatic stay!

What is the “Automatic Stay” and What Actions Does it Prohibit? (Continued)

Actions that a Landlord Generally Should Not Take Upon a Tenant Bankruptcy Filing:

1. Apply a security deposit against unpaid rent;

2. Demand payment of pre-petition rent;

3. Terminate a lease due to the bankruptcy filing or debtor’s insolvency;

4. Commence a lawsuit against a debtor that could have been commenced against the debtor prior to a bankruptcy filing; or

5. Continue a lawsuit already in progress against the debtor.

You Have Told Me What I Should Not Do--How About Telling Me What I Can Do?

Obtaining Relief from the Automatic Stay . . .

1. A bankruptcy court shall grant relief from the automatic stay “for cause.”

2. The Bankruptcy Code does not define “cause,” but with respect to a landlord, cause may include:a) A debtor’s failure to pay post-petition rent;b) The debtor’s lease expired by its terms prior to the bankruptcy filing; orc) The landlord terminated the debtor’s lease prior to the bankruptcy filing.

• Landlords must consult applicable state law to determine if a lease has been properly terminated before the commencement of the bankruptcy case.

Practice pointer: Even if a landlord is confident that it properly terminated a debtor’s lease before the commencement of the bankruptcy case, it would nevertheless be wise to seek relief from the automatic stay to pursue eviction or seek possession of the premises.

What Can a Tenant do with Its Non-Residential Lease Now That It is in Bankruptcy?

1. Reject the Lease 2. Assume the Lease3. Assume and Assign the Lease

When does a Tenant Need to Decide What It is Going to Do?

1. Nonresidential leases of real property are deemed rejected if the debtor does not assume or reject the lease within 120 days after the bankruptcy filing.

2. This period may be extended for “cause” only one time for a maximum of 90 days.

3. Subsequent extensions of the deadline may only be obtained with the landlord’s written consent.

4. A debtor must obtain a court order extending the deadline to assume or reject a lease prior to the expiration of the deadline.

What Does it Mean to Be Rejected?

1. A debtor’s decision to reject a lease is subject to the business judgment rule.

a) Rejection is routinely granted unless the decision is the product of bad faith, whim, or caprice.

2. Rejection is deemed a pre-petition breach of the lease by the debtor.

3. Effective date of rejection

a) Typically the date an order is entered approving rejection.b) Can be retroactive, particularly if the tenant surrendered the premises before a court order

is procured.

Can I Pursue Damages if My Lease is Rejected?

1. Landlords Can File a Rejection Damages Claim.

a) Because rejection is deemed a pre-petition breach of the lease, a rejection damages claim constitutes an unsecured claim against the debtor’s estate.

b) A rejection damages claim is capped as follows:

• All unpaid pre-petition rent, plus rent owed under the applicable lease for the greater of (A) one year, or (B) fifteen percent of the remaining term of the lease, but not to exceed three years of rent.

c) Proceeds from letters of credits and security deposits must be applied to the “capped” rejection damages claim.

2. Landlords are Entitled to an Administrative Expense Claim for Unpaid Post-Petition Rent.

a) When the effective date of rejection is on a date before the end of the month, courts differ regarding whether the landlord has an administrative expense claim for (i) the full month of rent, or (ii) rent prorated for only that portion of the month prior to rejection.

b) When rejection is effective as of the same date post-petition rent accrues, rejection likely takes precedence and the landlord will not be entitled to an administrative expense claim for that month’s rent.

What Should I Assume upon Assumption?

For a Tenant to Assume an Unexpired Lease of Nonresidential Real Property, it Must:

1. Cure, or provide adequate assurance that it will promptly cure, all defaults under the lease.

• All unpaid amounts owed by the debtor to the landlord under the lease as of the date of assumption, including rent and other charges arising both before and after the commencement of the debtor’s bankruptcy case.

• If such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated;

Assumption (Continued)

2. Compensates or provide adequate assurance that it will promptly compensate the landlord for any actual pecuniary loss to such party resulting from such default.

• Courts may consider several factors in determining whether and to what extent to include attorneys’ fees and costs in a landlord’s cure claim, including (1) the amount of the dispute relative to the attorneys’ fee requested, (2) the Debtor’s good faith effort to estimate and resolve the cure claim, (3) the Debtor’s compliance with the Bankruptcy Code, and (4) whether the issue is a matter of first impression.

3. Provides adequate assurance of future performance.

• Assurance that rent will be paid and other obligations satisfied after assumption.

What is This Assumption and Assignment of Which you Speak?

1. A debtor may assume and assign a nonresidential lease if the debtor (a) first assumes the unexpired lease and (b) provides adequate assurance of future performance by the proposed assignee of such lease.

2. Generally, a debtor may assign an unexpired lease “notwithstanding a provision in an . . . unexpired lease . . . or in applicable law, that prohibits, restricts, or conditions the assignment of such . . . lease.”

3. Lease provisions restricting assignment of leases to third parties, or requiring landlord’s consent to an assignment, are generally unenforceable in bankruptcy.

Will I Get Special Treatment as an Owner of a Shopping Center?

When a lease of real property in a shopping center is involved, section 365(b)(3) of the Bankruptcy Code provides certain conditions that must be satisfied to evidence “adequate assurance of future performance” such as:

1. The financial condition and operating performance of the proposed assignee and its guarantors, if any, shall be similar to the financial condition and operating performance of the debtor and its guarantors, if any, as of the time the debtor became the lessee under the lease;

2. Any percentage rent due under such lease will not decline substantially;

3. Assumption or assignment of such lease is subject to lease provisions governing radius, location, use, or exclusivity and assumption or assignment will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to such shopping center; and

4. That assumption or assignment of such lease will not disrupt any tenant mix or balance in such shopping center.

The Bankruptcy Code does not define “shopping center.” Rather, it appears that courts make determinations on a case-by-case basis. Generally, the factors that are considered — which need not all exist to establish a “shopping center” — are:

1. A combination of leases; 2. All leases held by a single landlord;3. All tenants engaged in the commercial retail distribution of goods;4. The presence of a common parking area;5. The purposeful development of the premises as a shopping center;6. The existence of a master lease;7. The existence of fixed hours during which all stores are open;8. The existence of joint advertising;9. Contractual interdependence of the tenants as evidenced by restrictive use provisions in their leases;10. The existence of percentage rent provisions in the leases;11. The existence of co-tenancy provisions in the leases;12. Joint participation by tenants in common area maintenance costs;13. The existence of a tenant mix; and14. The contiguity of the stores.

How do I know Whether My Property Qualifies as a “Shopping Center”?

What are the Tenant’s Obligations Pending Rejection or Assumption — What is “Stub Rent”?

1. Pending assumption or rejection, a debtor is required to timely perform its obligations under the lease “arising” after the bankruptcy filing.

2. Stub rent is the rent attributable from the date of the bankruptcy filing through the end of the month in which the case is filed.

3. Timing of payment depends on whether the case is proceeding in a “bill date” or “accrual” jurisdiction.

a) Bill Date Jurisdictions (e.g., Delaware): Because rent is due on the first of the month, these courts view the entire first month of rent as a prepetition obligation of the debtor. The post-petition portion will ultimately be treated as an administrative expense claim, but not payable until plan confirmation (together with the payment of all other administrative expense claims).

b) Accrual Jurisdictions (e.g., Southern District of New York): These courts prorate the first month of rent between the portion attributable to the days preceding the bankruptcy filing (the amount of which is included in a landlord’s general unsecured claim), and that attributable to the stub period and require that the latter be paid timely (meaning, relatively soon after the case is filed).

Store Closing Sales – It’s All About the Side Letter.

• Typically liquidators, and not the tenant, are running the store closing sale.

• The “Sale Guidelines” approved by the Bankruptcy Court to govern the course of conduct of a store closing sale usually leave something to be desired. A side letter agreement directly between the Landlord and the liquidators will help to better protect the Landlord’s rights and property by addressing, among other things:

o Enhanced signage restrictions;o Restrictions on augmentation of inventory by the liquidators;o An outside sale termination date; o Hours of operation;o Condition of the store; and o The Process for handling any violations of state or local law.

Q & A

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