Minimize Losses after a Tenant Enters Chapter 11
You’re a retail center manager. One of your tenants informs you that they are filing for Chapter 11 bankruptcy. What can you do?
First, don’t panic! As a real estate manager, you can help mitigate damages by becoming familiar with the process. First, start thinking about the market demand for the space; the current market rent and how that compares to the lease rent; how the loss of the tenant could impact the owner’s obligations to the mortgagee; and the costs to replace the tenant.
When a tenant files for Chapter 11, you must act quickly by filing a Notice of Appearance and Demand for Notices through counsel. This allows you to receive notification of important events in the case, including the tenant’s submission of a budget in order to secure a debtor in possession financing. You can use this information to ensure that the rent is included in the tenant’s budget, and to ascertain whether the tenant is capable of fulfilling outstanding lease obligations.
The tenant will have an opportunity to “assume,” “reject” or “assign” its leasehold interests.
A tenant who assumes a lease intends to fulfill the remaining lease obligations. Tenants who want to assume leases must:
1. Cure any monetary defaults
2. Compensate landlords for damages stemming from monetary defaults
3. Furnish adequate assurances that remaining obligations will be fulfilled
4. Satisfy all remaining obligations.
Rejection releases the tenant from rental payments as well as other continuing lease obligations. Rejected leases are regarded as having been defaulted just before the bankruptcy filing. When a lease is rejected, the landlord is entitled to a rejection damage claim, typically yielding only a fraction of the face value of the claim.
Tenants may assume and then assign a lease to another entity. This typically occurs when the existing lease is at a below average rent, so the tenant can sell the lease and earn money for the bankrupt estate. Luckily, the bankruptcy code provides obligations that help protect the landlord in such cases. Shopping centers in particular are singled out with strict obligations to protect the landlord and the viability of the center.
By understanding the provisions of the bankruptcy code, you can enhance the value of spaces leased to bankrupt tenants, their neighbors’ leases and your owners’ properties. The ability to make the most out of a bad situation is a skill worth cultivating.
Read more about Chapter 11 in the July/August issue of JPM