In April 2023, home goods behemoth Bed Bath & Beyond filed for Chapter 11 bankruptcy. Six months later, East Coast pharmacy giant Rite Aid followed suit. In both proceedings, the debtors announced plans to shutter hundreds of locations as part of their liquidation efforts.
When those two chains went dark, commercial landlords across the country faced the prospect of empty storefronts and diminished cash flow. In both bankruptcies, the debtors have sought to sell or auction off those leases to new tenants and, in many instances, have succeeded. But even in those cases, those landlords still must address the prospect of dealing with new tenants, their compatibility with any other lease covenants, and their ability to fulfill lease obligations.
Though not every bankruptcy is on the scale of these two cases, countless commercial property owners deal with this situation every year. Understanding what owners – and tenants – can and can’t do during tenant bankruptcy proceedings is critical for landlords seeking to protect their interests.
Lessees in Bankruptcy Have a Choice To Make: Assume, Reject, or Assign Their Lease
Bankruptcy Code Section 365 is the primary statutory section governing the treatment of commercial leases in bankruptcy. At the outset, the landlord’s ability to take any action to protect itself is seemingly limited, given the automatic stay. But the fact that a tenant starts the process largely controlling its lease’s destiny and obligations thereunder does not mean the landlord should stand idly by. Early involvement and engagement with the court and debtor allows a lessor to impact and influence the fate of their lease.
Section 365 provides that a debtor/lessee has 120 days after filing its bankruptcy petition (plus an additional 90 days, if good cause shown) to assume, reject, or assign/auction/sell the lease. (In the Rite-Aid case, the debtors have asked landlords to agree to a lengthy extension of time for the debtors to decide their course of action on the leases, despite the limitations of Section 365.)
Throughout this period, the lessee must satisfy its lease obligations. If the lessee fails to declare its intentions before the deadline, the lease will be considered rejected, meaning the tenant must vacate the leased premises.
Assumption
If the debtor chooses to assume its lease, it effectively declares it wants the lease to continue as it existed pre-petition. In this case, the lessee must cure any defaults, compensate the lessor for any losses caused by the default, and provide “adequate assurance of future performance” of its lease obligations.
Rejection
If the debtor cannot or elects not to assume the lease, it can reject the lease. A rejection operates as a de facto breach, and the tenant must accordingly vacate the leased
premises. Upon the rejection of the lease, the landlord may pursue a claim for “rejection damages” though the Code puts a cap on those damages.
Sale/Auction/Assignment
Notwithstanding any provisions limiting or prohibiting the rights of the tenant to assign the lease, the tenant can attempt to assign, sell, or auction it if the court approves of such a course of action. That is precisely what Bed Bath & Beyond and Rite Aid have done.
As is the case if the lessee assumed the lease, it must cure all defaults, and the assignee/purchaser of the lease must provide adequate assurance of future performance. Shopping center owners are entitled to even more protections. Failure to deliver adequate assurances can be the basis of a landlord’s objection to any assumption, assignment, or sale.
While a tenant bankruptcy can be disruptive, it need not be a catastrophe. Skilled bankruptcy and real estate counsel can move quickly to protect a commercial landlord’s rights and enhance its ability to emerge from proceedings in a solid position to continue receiving much-needed cash flow.
