Preemptive Surgery
Mar 1, 2009 12:00 PM, By Denise Kalette
Shifting Bankruptcy Laws
Unlike previous slowdowns, when a company could emerge from bankruptcy court as a healthier and leaner version of its old self, the example of more than two dozen high-profile retailers over the past year shows that, more often than not, the path to a bankruptcy filing is a swift and jarring road to liquidation.
When Richmond, Va.-based Circuit City Stores filed a petition in U.S. Bankruptcy Court under Chapter 11 of the Bankruptcy Code last November, executives first shut 155 stores. They kept the doors open at 567 superstores, but those efforts weren't enough. On Jan. 5, the company asked the court's permission to put the chain up for sale. When two potential investors expressed interest and negotiations started, landlords across the country hoped that the tenant chain might survive under a new owner. But when no deal occurred by the Jan. 16 court deadline, Circuit City took steps to liquidate its assets.
Changes to the federal bankruptcy law in 2005 made it tougher to emerge from Chapter 11, says Keith Shapiro, former chairman of the American Bankruptcy Institute and now an attorney with the Chicago office of Greenberg Traurig. The legislation reduced the time retailers have to decide which leases to keep or reject. Retailers now have 210 days, including an extension.
“They have a very powerful right to walk away from leases with minimal damages,” Shapiro says. Another development is the new clout of junior lien holders such as hedge funds. Some of the liens stem from mezzanine loans, he adds.
A property owner or retailer facing bankruptcy needs debtor-in-possession (DIP) financing to pay operating expenses while restructuring. But with credit scarce, many borrowers are at the mercy of their existing lenders, who may be in no mood to issue a new loan to a defaulting client, Shapiro says.
On the first day of a bankruptcy case, the judge typically issues first-day orders, including interim approval of DIP financing. A liquidator may help close unprofitable locations and sell real estate inventory.
If dumping leases and chopping costs aren't enough, a company can hunt for a buyer. But realistically, a cash-strapped retailer may make just a brief stop in Chapter 11 before calling it quits. “If there's no buyer for a retailer, a lot of lenders are now forcing liquidation,” says Solomon. No longer can a retailer make a pit stop in bankruptcy, drop underperforming stores and turn things around. He contends, “That playbook has fallen by the wayside.”
Steps for Survival
If a shopping center has lost a key tenant and other tenants are threatening to leave, a landlord needs to take steps to forestall a disastrous exodus and potential insolvency. Here are five steps owners can take to stay solvent and avoid bankruptcy, based on advice from financial consulting firms.
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Take Stock — examine your retailer base and determine what steps you can take to assure the center's long-term viability. Try to understand your tenants' needs. Some may be facing bankruptcy.
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Renegotiate Lease Terms — you may need to bite the bullet and renegotiate a tenant's lease before the current term expires. As consumer spending has waned, many retailers' incomes have declined. Reducing the rent may keep the space occupied, and less income is better than none.
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Offer Short-Term Relief — consider a brief rent-free period. This may strengthen the retailer's financial position in the long run.
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Fill Vacancies Quickly — when a major tenant exits, find a replacement fast. If a remaining retailer's long-term prognosis is poor, line up a new candidate and negotiate for early possession of the space. Anticipate that a retailer in Chapter 11 may reject its lease, and prepare to rent the profitable space.
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Talk to the Lender — negotiate with the shopping center lender for more favorable financing, just as tenants negotiate with the landlord. — Denise Kalette
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