Now What?
Sep 1, 2008 12:00 PM, By Kerri Linden
Working with retailers
Certain retailers have better reputations than others when it comes to reneging on lease agreements. Landlords have been unhappy with how Starbucks has handled its recent bout of store closings. It sent out mass notices of termination agreements to landlords, demanding a signature even before owners had had a chance to sit down with the coffee chain to negotiate. “Starbucks has been sending letters saying ‘We're doing this.’ But they don't have a unilateral right to terminate,” says Tara Scanlon, a partner with Holland + Knight, a Washington, D.C.-based law firm specializing in commercial real estate. “If they haven't made an agreement with the landlord to go dark, they need to work out an agreement. If the landlord doesn't mind that it's vacant, he can sign the agreement without a problem, but some might have a problem with it.” A Starbucks spokesperson said that the retailer will work with all its landlords to negotiate termination agreements.
A lot of the lease settlement depends, in the end, on a retailer's financial situation, and the leverage it has in terms of its real estate. But retailers must tread carefully in working out multiple leases. Major retailers with healthy balance sheets trying to get out of multiple leases on good real estate generally won't run into trouble on settlements, Graiser says. “But large retailers need to be consistent with all parties,” he adds. “Landlords will talk to each other and will find out if there are inconsistencies and are being paid less than someone else to settle.”
The retailer, who has an obligation to the lease legally, does not have to find a new tenant for the landlord, but may either find itself faced with very high costs to terminate, or oftentimes, denied a termination agreement. As a result, many retailers find it less of a hassle to just pay rent on a dark space rather than go through protracted lease termination talks, Friedman says. He points to firms like Circuit City, McDonald's and Wal-Mart as firms that are currently sitting on empty real estate because the companies decided it would cost less to do that than to go through termination talks.
Bankruptcy pains
If a retailer enters bankruptcy, however, it becomes an entirely different matter.
It used to be that retailers filing for bankruptcy had 60 days to assume or reject a lease after filing for bankruptcy, but they could also file for repeated 60-day extensions. In the end, landlords were often left waiting for six months or longer as tenants filed repeated motions.
In 2003, however, Congress reformed bankruptcy laws. Under current rules, tenants actually get a longer initial period — 120 days — to assume or reject a lease. But now they are limited to one 90-day extension. Leases can only be extended beyond that if the landlord agrees. In essence, landlords are left with a 210-day period during which they cannot look for a replacement tenant or collect rent from the current one. After that, landlords can gain control of the space. “They're in a holding pattern,” Scanlon says. But at least now the holding pattern has a definitive end.
While it may be easier today to get control of space occupied by a bankrupt tenant, it remains difficult to collect back rent. Landlords can make claims for unpaid rent. In the process, they get added to a queue of creditors, most of whom will only ever get paid a fraction of what they are owed. It's not unusual for creditors in a bankruptcy proceeding to collect 15 percent or less of what they are ultimately owed. And in these situations, which firms get paid is entirely up to a bankruptcy court judge, who divides up assets and allocates them, Scanlon says. “It's unfortunate, because it works to the disadvantage of the ‘nice guy,’ the landlord who lets things go,” she says.
The nature of bankruptcy today, too, has changed. What was once thought of as a break in operations to streamline and reorganize before reopening for business is now becoming a process solely for organizing a company's liquidation. “The traditional retailer isn't looking at bankruptcy as a genuine reorganization anymore,” says Ed Dolan, partner in Washington, D.C.-based firm Hogan + Hartson, which specializes in bankruptcy cases. Dolan points to opportunistic funds and liquidators that buy a bankrupt retailer's leases in order to re-lease them or sell them. The problem for landlords, then, is that they don't have much input on who the replacement tenant becomes. As a result, less retailers than ever are emerging from bankruptcy. Graiser estimates that 95 percent of the time now retailers are not emerging from bankruptcy.
