By Kenneth A. Rosen, Lowenstein Sandler LLP
It’s never good when a retailer files for chapter 11. But there’s at least one silver lining: Retailers, with Bankruptcy Court approval, can override contract provisions and sell leases — despite landlords’ objections.
In fact, the difference between the value of contract rents and the value of market rents (a distinction I’ll address shortly) can actually fund a reorganization, help pay off a lender’s claim and enable a dividend to unsecured creditors. Put another way: The sale of these leases has become big business as mall owners and tenants adapt to an evolving marketplace.
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Consider the factors affecting traditional retailers and shopping centers:
Many communities simply have too many malls. While “A” malls generally continue to prosper, “B” and “C” malls must reevaluate to remain relevant. There’s also increased pressure to provide engaging experiences to shoppers along with amenities — e.g., WiFi, dining options, children’s entertainment, areas for rest and relaxation and available parking. Individual retailers also must provide customers with the benefits of online retailing that complement the bricks-and-sticks experience. A smart retailer must consider its leased space and, increasingly, the space outside, down the hall and into the near and far community.
So, for bankrupt retailers whose contract rent is less than their market rent — where new tenants would be getting a good deal on rental rates — selling the leases can be a much-needed source of cash. This is where the difference between contract and market rent comes in. But, one must ascribe a value (positive or negative) to the owner’s investment track record and to the shopping center’s ability to stay competitive in attracting customers, given anchor tenants, satellites, expected changes in community demographics, competition for leisure time and ability to compete with e-Tailers. This effectively increases or decreases the present value of the lease being sold.
However, the analysis does not end there. For landlords who invest heavily in their properties, prospective lease assignees may pay more than the arithmetical difference between the present values. In order to maximize the sale price of the assignment the consultant must fully understand the landlord’s investment track record and plans for further investment in order to push the price in excess of the difference in present value.
As noted, chapter 11 debtors need Bankruptcy Court approval to sell leases. The sale process moves rapidly because the debtor incurs an administrative obligation for post-bankruptcy rent. With the changing shopping center and retail environment, the analytics necessary to monetize leases for maximum value are more detailed and individualized. Therefore, it’s necessary to begin the process further in advance of the petition date. Smart potential assignees will ask many more questions. And, the sale process requires that prospective tenants get more information. The Bankruptcy Code limits the time in which a debtor must assume or reject (surrender) a real estate lease to 270 days from the petition date. However, the actual window can be much shorter because, to commence and complete a “GOB” sale and vacate within 270 days, a decision must be made much sooner.
Selling leases isn’t easy. In an incredibly difficult era for retailers, they need to be much more knowledgeable of information affecting lease values if they are going to be able to maximize the cash to emerge from chapter 11.
Kenneth A. Rosen is an attorney and Chair of Bankruptcy, Financial Reorganization and Creditors’ Rights Department at Lowenstein Sandler LLP. The views expressed herein are those only of the author and are not necessarily those of any other attorneys at Lowenstein Sandler LLP or of the Firm.
