Retail Tenant Bankruptcies: A Shift in Favor of Landlords' Bids to Terminate Leases
The disruptive impact of e-commerce and technology, as well as changes in consumer behavior, on the “bricks and mortar” retail industry is well-documented. These trends have led to widespread retail bankruptcies and store closures over the last few years. In 2017 alone, more than 30 national retailers filed for bankruptcy protection, and industry experts expect this trend to continue. Correspondingly, these trends have also led to a significant decrease in the demand for acquiring the leasehold interests of bankrupt retailers.
Prior to this decline in the retail real estate market, when a national or regional retailer auctioned or offered for sale its leasehold interests during the pendency of its bankruptcy case, there was usually considerable competition – both from real estate owners/developers and other retailers – to acquire these leasehold interests. The ability to obtain leasehold interests in desirable locations, often at below-market rents and on other anchor-friendly lease terms, through retail bankruptcies was very attractive to owners/developers and other retailers. Moreover, because anti-assignment provisions in leases are generally unenforceable in bankruptcy, the purchaser (i.e., assignee) of the leasehold interest was able to take over the lease without obtaining the landlord’s consent (so long as the assignee evidenced its ability to perform the tenant’s ongoing lease obligations).
Even where the bankruptcy court permitted landlords to bid on their own leases in a bankruptcy auction (in effect, to bid to terminate the lease), or where the debtor was willing to consider such bids from landlords outside the auction context, landlords often found it difficult to prevail against parties who were in positions to bid for entire packages of leases across multiple properties. In particular, representatives of the bankruptcy estates have considerable discretion to determine which offer is the “highest or otherwise best” for the sale of the retailer’s leases, and such representatives most often favored selling the leases in bulk over one-off sale transactions with individual landlords.
Because of a bankrupt company’s power to assign leases without the landlord’s consent and the considerable historical third-party demand for retail leasehold interests, landlords were frequently forced to accept the risk of inheriting a new tenant that they did not want, or accept a new tenant under lease terms that the landlord would not have otherwise offered that tenant at the time the lease was assigned. Among other risks presented by such an “unplanned” tenant, in some instances the assignee’s acquisition of the lease and its subsequent use of the demised premises, have triggered the failure of co-tenancy conditions under other leases within a shopping center.
Shift in Favor of a Landlord's Bid to Terminate
With the retail real estate market now distressed and over-built, there appears to be less demand from real estate owners/developers and other retailers to acquire the leasehold interests of bankrupt retailers, placing landlords in a more competitive position to bid on their own leases. In addition, the various “best” strategies to redevelop a vacant or partially vacant retail shopping center have shifted, and are now primarily driven by the local market in which each particular shopping center is located. Accordingly, fewer bidders are currently interested in acquiring a package of leases across multiple markets.
These current market forces have given landlords an opportunity to successfully bid to terminate their leases with a bankrupt tenant, as witnessed in the pending Toys “R” Us bankruptcy. In April 2018, Toys “R” Us completed the assignment or termination of several dozen leases in its portfolio across the country. The bankruptcy court in that case authorized current landlords to submit bids to terminate their own leases, including by “credit bidding” the amount of existing arrearages. Although landlords often will need to bid cash (in addition to any amount that may be available to credit bid), in today’s market a credit bid alone may be sufficient to secure landlords a seat at the auction and the ability to compete against other bidders for their leases.
Of the nearly 100 leases that Toys “R” Us has submitted to auction so far, the landlords for nearly three dozen locations have successfully bid to terminate their leases, including the owner of a prominent New York City retail development represented by Tannenbaum Helpern’s real estate and bankruptcy practices.
Landlords now have a greater opportunity to successfully bid to terminate (or negotiate a termination of) their leases with a bankrupt retail tenant, thereby taking control of the planned redevelopment and use of the space. What has not changed, however, is the need for the landlord to determine - as a business matter - whether there is value in terminating the bankrupt tenant’s lease, and if so, how much should the landlord be willing to offer or bid to obtain a termination.
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