If you are a commercial landlord these days, you’ve probably had one (or more) of your national chain tenants file for bankruptcy within recent memory. Though the Bankruptcy Code gives Chapter 11 debtors an almost absolute right to walk away from unprofitable leases, some national chain debtors have used that power as a weapon, in order to extract significant concessions from their landlords. Landlords often give those concessions, because they think that they have little or no choice, and that half a loaf (or, more accurately, half a lease payment) is better than none.
It doesn’t have to be that way. Here’s how the game usually goes.
THE GROUND RULES
Under the Bankruptcy Code, debtors have up to 210 days from their bankruptcy filing date within which to decide whether to keep (“assume”) or walk away from (“reject”) their leases. During that time, the Code requires the debtor to pay rent each month to each landlord whose real property continues to be used for the operation of the debtor’s business. If a debtor doesn’t pay post-petition rent automatically, take it as a sign that the squeeze is coming.
Meanwhile, you may safely assume that the debtor knows, before even filing its bankruptcy petition, exactly which of its locations are solidly profitable, which generate only a middling profit (but could make money with landlord concessions) and which are absolutely irredeemable dogs.
Nevertheless, the debtor will probably ask all of its landlords for rent concessions, and might even ask the “dog” landlords for greater concessions than the others, on the premise that there’s no harm in asking; if a “dog” landlord balks, they simply walk away from that location.
RESPONDING to the DEMAND for CONCESSIONS – KNOWLEDGE is POWER
For a landlord, knowing which category its location falls into is extremely useful information. If a lease contains reporting requirements, then the landlord might be able to estimate the store’s profitability from information that it already possesses. If not, the landlord could perhaps gain insight from talking to others in the commercial leasing world; the debtor will almost certainly refuse to share any financial information about a particular location with that location’s landlord.
When a demand for concessions comes in, the landlord’s first task is to determine whether continuing to lease to the debtor would make financial sense under the proposed terms. If the answer is “no”, then one valid strategy is to refuse the proposed concession, and be ready for the lease to be rejected. However, if the location is profitable for the debtor, the lease might be assumed anyway; if this happens, you have called the debtor’s bluff.
Another useful strategy in responding to a demand for concessions is to make a counterproposal with an “early out” to protect the landlord.
If a lease has many years to run, but the landlord doesn’t want to rent to the debtor long-term (and doesn’t have any short-term prospects to re-rent the space), and is reasonably certain that — without concessions — its lease will be rejected, the landlord might agree to concessions that would ordinarily not be acceptable, in exchange for the ability to terminate the lease years before its scheduled expiration date. Since most bankruptcy reorganizations fail, this would protect the landlord from being locked into a long-term discounted deal with a debtor who might ultimately end up in a second bankruptcy, in which the unprofitable lease could be sold to a third party over the landlord’s objection.
An “early out” provision can also give the landlord a chance to participate in the upside if the debtor successfully reorganizes: the debtor could be given the right to avoid early termination by paying some portion of the forgiven rent, by paying a higher rent going forward, or both.
The renegotiation sword can indeed cut both ways.
On the other hand, if the landlord knows (or strongly believes) that its location is solidly profitable, it can go “all in”. In this scenario, the landlord tells the debtor that it will not even consider a demand for concessions unless the debtor provides profitability information for the location in question. In most cases, the debtor will refuse; at that point, the landlord should simply go on “radio silence”. If the location is indeed as profitable as the landlord believes, then the chances are good that the debtor will ultimately swallow its pride and assume the lease unmodified.
Even in the case of a profitable location, a debtor’s demand for concessions can sometimes be turned to the landlord’s advantage. “Early outs”, recaptures, and other landlord-friendly modifications can often be obtained in exchange for relatively modest concessions if the location is solidly profitable for the debtor.
Generally, a landlord can force a debtor to decide whether to assume or reject a lease, but can’t force the debtor to pick one over the other. Still, applying the psychology of a poker player to the demand for concessions can often lead the debtor in the landlord’s preferred direction.
Don’t assume that you’ve lost until all the cards have been revealed. -30 –