Impact of bankruptcy on landlords: At times, a waiting game
It seems with nearly all current economic issues, one can relate back to the pandemic. Just a few years back, the unprecedented impact of the pandemic was felt worldwide, influencing economies and politics. For the most part, at least in the early months in the United States, unless a business was considered “essential”, the doors were shut with initially no indication of when employees and customers would be welcomed back. While the effect on business owners, generally, and retail and franchise operators, specifically, was disastrous, causing many to seek restructuring or bankruptcy alternatives, the effect on landlords was no less harmful. At that time, many landlords found themselves without a regular stream of rental income (or, no more than a reduced stream of rental income), compounded by retailers and franchisees ultimately ceasing business, and culminating in landlords unable to find replacement tenants, particularly in the immediate aftermath of the restrictions imposed both locally and nationally.
Although it took time, the county rebounded from the pandemic, part and parcel of that being that retail and franchise businesses reopened and operated substantially similar to pre-pandemic days, with consumers leaving their homes, confident enough to be among crowds.
From 2020 to 2021, the number of bankruptcies, retail and franchise specific, fell over 50% - and from 2021 to the latter part of 2022, the number dwindled further. However, with the impact of many factors beginning in late 2022, including socio-economic and political factors, resulting in, among other things, rising interest rates, a decline in consumer spending, and an increase in commodity pricing, retail and franchise businesses experienced a somewhat tumultuous late 2022 and early 2023.
The retail filings ran the gamut from sporting goods (Olympia Sports) to home furnishings (Sears Hometown), party goods (Party City), pet supplies (Independent Pet Partners), and home-goods (Tuesday Morning). Furthermore, there were several fast food franchisees that filed, including Burger King (Meridian Restaurants Unlimited and TOMS King), Popeyes (Premier Cajun Kings) and McDonalds (Rice Enterprises). While the reasoning behind each filing differs, with not all associated with the factors noted above, the result, as least pertaining to those locations in which the real estate is subject to a real property lease, can be damaging to landlords.
Landlord concerns when a tenant files bankruptcy
There are several general concerns for landlords upon a tenant’s bankruptcy filing, whether retail or franchise, including, but not limited to, delayed or lost rental payments, the inability to evict the tenant and the further inability, under most circumstances, to unilaterally terminate the lease. More specifically, however, when a landlord is faced with a tenant bankruptcy, there are several potential outcomes with respect to the landlord-tenant relationship as a result of certain relief afforded the tenant under the bankruptcy process and the Bankruptcy Code; namely the ability of a tenant to assume, assign or reject the underlying lease. In each instance, this decision must be made within 120 days of the bankruptcy filing, unless extended by the Bankruptcy Court.
- If the tenant assumes the lease, and remains in possession, the tenant must cure all obligations in arrears, in addition to provide adequate assurance of future performance.
- If the tenant assigns the lease to a third-party, which typically results from a sale of the tenant’s assets, the outstanding obligations in arrears must be cured, and the new, third-party tenant must provide adequate assurance of future performance.
- Lastly, if the tenant rejects the lease, the property is turned-over to the landlord and the tenant has no further obligation for rent going forward, post-filing. In conjunction with this, the landlord possesses an unsecured, rejection damages claim, the amount of which is determined by certain provisions of the Bankruptcy Code. It is important to note that while the tenant decides which avenue to pursue, it is obligated, within 60-days of the filing, to remit post-petition rent to the landlord, unless extended by the Bankruptcy Court.
While the above addresses the more distinct outcomes, governed by rule or process, based on the retail or franchisee tenant’s decision to assume, assign or reject a lease, there are certain realities imposed on a landlord under each. If the underlying lease is assumed, the landlord is in, arguably, the same position it was prior to the tenant’s filing, with the tenant bringing current all past due obligations. If the underlying lease is assigned, the landlord, though having the outstanding obligations under the lease brought current (in full, or a negotiated sum), finds itself with a “new” tenant that, presumably, was not necessarily vetted pursuant to the landlord’s typical procedures. Furthermore, it is likely the new tenant will seek certain concessions from the landlord, including, but not limited to rent and term, in order to take over the obligations of the defaulted tenant, knowing of the landlord’s limited alternatives. Lastly, if the underlying lease is rejected, placing the landlord back in possession, it certainly permits the landlord to re-let, but that may come with the unanticipated cost of improvement or build-out, specifically if the property was special purpose (e.g., a particular retail or franchised business constructed pursuant to distinct specifications).
This brief article is not positioned to outline all rights or alternatives available to a landlord when it finds itself with a tenant in bankruptcy, but rather to provide general considerations. The franchise and strategic advisory and restructuring professionals at McDonald Hopkins are uniquely positioned to provide reasoned and experienced counsel to landlords should they find themselves in need of guidance in such bankruptcy or distress situations.