By: Thomas S. Onder, Shareholder, Stark & Stark
RadioShack, A&P, Wet Seal, Joyce Leslie, Sports Authority and PacSun are just a few of the big retailers to file for Chapter 11 bankruptcy protection during the last 18 months. Vestis Retail Group, which is the owner of Eastern Mountain Sports, Bob’s Stores and Sport Chalet chains, also just has filed. Speculation abounds that a number of other retailers are expected to file in 2016, potentially including Fairway Market and Sears, which owns and operates both the Sears and Kmart brands.
Shrinking margins, high debt loads, increased competition and the changing shopping habits of millennials are putting pressure on retail tenants, who are being forced to “right-size” or find the happy medium between brick-and-mortar stores and an online presence. In some cases, Chapter 11 bankruptcy protection offers tenants an opportunity to shed unprofitable stores and provide a new business model for the 21st century. For landlords, navigating the bankruptcy process is critical to protecting the leasehold interest. The following are some proactive steps to take in this next wave of retail bankruptcy cases.
Stay Current with Rents
The Bankruptcy Code only allows tenants to assume or reject a lease in a bankruptcy case if the lease has not expired or terminated prior to the bankruptcy filing. As such, landlords should ensure that they are current with rent. If a tenant is not, it is advisable to call any defaults that may exist sooner rather than later. It is better for a landlord to spend a couple hundred dollars to file an eviction action and be brought current, than to allow an arrearage to build up and potentially be presented with a Chapter 11 bankruptcy petition.
Limit Exposure from Potential Avoidance Actions
Even if you terminate a lease prior to bankruptcy, it is possible for the tenant to later argue that the value of the lease is an avoidable transfer under Bankruptcy Code Sections 547(b) and 548(a)(1). These Code Sections permit the filing of a complaint to recoup the value lost to the Debtor.
Recently, in a case out of the Seventh Circuit — Great Lakes Quick Lube, LLP, 528 BR 893 (ED Wisc. 2016) — the court held that an action by the creditors’ committee to find two profitable leases terminated pre-bankruptcy with three unprofitable leases could proceed as an avoidance action. Therefore, the creditor could have to give money back to the Debtor for the value of the two profitable leases. The case was remanded for the Bankruptcy Court to determine if there was any value in the two leases, and if there were any applicable defenses. The outcome is being closely watched.
In the interim, it is advisable that when a lease is terminated by consent, unilaterally by landlord or by Court order, a landlord should document any lack of value of the leases, including a review of liability for non-payment of rent, covenant defaults and/or other requirements under the lease. Incorporating this reasoning into any agreement, order or correspondence can provide a coherent defense if an avoidance claim is filed a year or two after the bankruptcy case commences.
Ensure Operations has Information in the Event of Store Closure
It is also important to ensure that your operations personnel are apprised of efforts in the bankruptcy, and how they pertain to the physical location. For instance, when was the last time your property manager spoke with the store manager to obtain important security codes, HVAC and utility information and conducted a walk-through? Having that information on hand can help avoid real world property issues, like frozen or burst pipes, if a Debtor abandons the property or fails to maintain the premises. In bankruptcy, you want that information before a store is potentially neglected or abandoned.
Stub Rent, Administrative, and Pre-Petition Claims
Stub rent is the amount due to a landlord for the period of use and occupancy between the bankruptcy filing date and the first post-petition rent payment. The jurisdiction that the Debtor files for bankruptcy protection will effect this payment. Courts use either the accrual/proration or billing date approach to determine when the rent obligation accrues and when it is due. Courts in the Second, Ninth and Tenth Circuits follow accrual/proration approach where the rents will accrue on a pro-rata basis.
Under this approach, if Debtor’s rent is due on January 1, but filed for bankruptcy on January 5, they must immediately pay this stub rent for the period January 5 thru 31. The Third, Sixth, and Eighth Circuits follow the billing date approach where rents accrue when billed. For example, if Debtor’s rent is due January 1, but filed for bankruptcy on January 5, the first post-petition rent payment would be due February 1. However, the landlord can still assert stub rent as an administrative expense claim for the period January 5 thru 31, but the court may not order immediate payment.
At the outset of a bankruptcy case, this issue is extremely important and can be used as leverage for the landlord to assert objections to the motion to extend the time period to assume or reject issues concerning sales and bidding, as well as a host of other pleading filed by the debtor.
Commercial landlords and trade creditors should speak with bankruptcy counsel now to formulate and execute a plan in the event of a likely bankruptcy filing. When a debtor files for bankruptcy protection, be sure to ask your counsel: (1) Will they remain a tenant?; (2) When will rent be cured?; (3) Are there pre-petition claims that are owed?; (4) When will “Stub Rent” be paid?; and (5) What other damages are owed? Taking a proactive approach can help limit exposure, keep you current and ensure that you are protected during the next retailer bankruptcy.
Stark & Stark’s Creditor’s Rights Group regularly represents landlords throughout the country, including recently in the District of New Jersey, Southern District of New York, District of Delaware and Eastern District of Pennsylvania on a variety of issues. Most recently, we have represented landlords and trade creditors in the RadioShack, A&P, Joyce Leslie and Sports Authority Chapter 11 bankruptcy cases.
Thomas Onder is a shareholder at Stark & Stark. For more information, he can be reached at (609) 219-7458 or [email protected]. Mr. Onder writes regularly on commercial real estate issues and is a member of ICSC and Chair of the 2016 ICSC PA/NJ/DE Next Generation Committee.