Legal News TM

REAL ESTATE Legal News TM

JUNE 2007

Key Considerations for Commercial Landlords When Faced With a Legal News: Real Estate is part of our Tenant’s Bankruptcy ongoing commitment to providing legal By Jill L. Murch insight to our clients and our colleagues. Perhaps one of the most dreaded words in a commercial landlord’s lexicon is “bankruptcy.” Indeed, a If you have any questions about this issue tenant’s bankruptcy can present pitfalls for an unwary landlord. Upon a tenant’s bankruptcy, myriad or would like to discuss these topics rules and provisions spring into effect, often curtailing a landlord’s rights under the underlying further, please contact your Foley attorney lease. This article highlights certain key considerations for a commercial landlord when faced with a tenant’s bankruptcy. or any of the following individuals: The Automatic Stay Elizabeth L. Corey, Chair Upon the tenant’s bankruptcy, the landlord is no longer free to exert unilateral control over the Chicago, Illinois tenant’s leasehold interest — even if such action is contractually bargained for under the lease. 312.832.4585 Instead, the United States Bankruptcy Code’s (Bankruptcy Code) automatic stay prevents, inter alia, [email protected] actions by a landlord to obtain possession or exercise control over property of the estate. In other words, the automatic stay is a sweeping injunction that prevents creditors from dissipating or diverting assets of the estate.1 This includes actions that may be taken by commercial landlords. Contributing Authors: Before a landlord may take action against the debtor and its property, the landlord must first seek relief from the bankruptcy court to lift the automatic stay. Unwitting landlords who fail to obtain such Donna J. Pugh permission will find themselves in violation of the stay, rendering their actions either void or voidable.2 Chicago, Illinois 312.832.4596 Ipso Facto Clauses [email protected] Although pervasive in commercial leases, ipso facto clauses (clauses “by which a contract is terminated as a result solely of the debtor's insolvency or bankruptcy”) will not be given effect in bankruptcy since they are viewed as hampering a tenant’s ability to reorganize.3 Indeed, such clauses Jill L. Murch provide little solace to landlords within the confines of a bankruptcy case. Chicago, Illinois 312.832.4522 Assumption and Rejection of Commercial Leases [email protected] The Bankruptcy Code grants a tenant the earlier of 120 days after the entry of the order of relief4 or the date of the entry of an order confirming the debtor’s bankruptcy plan to decide whether it will continue to be bound by the lease, i.e., assume the lease, or whether it will reject the lease.5 If the debtor fails to Contributing Editor: assume the lease within this period, the lease is automatically deemed rejected.6 Prior to the enactment Matthew V. Munro of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) on October 17, 2005, a Milwaukee, Wisconsin debtor could make multiple requests to the bankruptcy court to extend the time to assume or reject a lease as long as the debtor demonstrated “cause.” 414.297.5570 [email protected] However, the BAPCPA has significantly bolstered landlords’ rights by capping such extensions. Under the BAPCPA, a debtor may, prior to the expiration of the 120-day period, request that the bankruptcy court extend this period for up to an additional 90 days upon a showing of cause.7 Any subsequent extensions may only be upon the prior written consent of the landlord.8 As a result, a tenant now only

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has 210 days after filing for bankruptcy to decide whether it will assume such termination, including the recovery of alleged fraudulent transfers or reject its lease, absent a landlord’s consent. This limitation is and/or preferences; the possible setoff of security deposits; and whether particularly relevant to large commercial retailers with multiple leases, leases are considered disguised financing agreements to name just a few. who are now required to strategically evaluate their leases well in advance As such, it is recommended that any landlord who suspects a tenant may of a bankruptcy filing.9 be filing for bankruptcy consult with a legal professional to plot a proper and comprehensive course of action. If a tenant opts to assume the lease, it must: (1) cure or provide adequate

assurance that it will cure defaults under the lease, including defaults 1 11 U.S.C. § 362(a)(3). related to non-monetary obligations under the lease; (2) compensate or 2 11 U.S.C. § 365(d). Section 365(d) permits a landlord to lift the injunction imposed by the stay by provide adequate assurance that it will compensate the landlord for any demonstrating that “cause” exists (including a lack of adequate protection) or that the tenant lacks equity in the property and the property is not necessary for to an effective reorganization. actual pecuniary loss to the landlord resulting from the defaults; and (3) 3 See, e.g., EBC I, Inc. v. America Online, Inc., 03-50003, 2006 WL 3525031, at *7 (Bankr. D. Del. provide adequate assurance of future performance under the lease. Dec. 7, 2006); 11 U.S.C. § 365(e)(1). 4 Note that the order for relief is self-executing and is deemed entered on the date the debtor files its bankruptcy petition in a voluntary bankruptcy case. However, in an involuntary bankruptcy case, the If the tenant rejects the lease, the landlord is left with a general unsecured petition date and the date of the order of relief may not be the same. 10 claim for damages, subject to a cap. The cap limits the landlord’s 5 During the period between the tenant’s bankruptcy filing and its determination whether to assume or damages claim to the following: reject its lease, the tenant must continue to perform its obligations under the lease. 11 U.S.C. § 365(d)(3). In other words, although the tenant is not required to pay pre-petition rent, the tenant must make post-petition rent payments. The bankruptcy court may extend the time for the tenant’s post- (A) The rent reserved by such lease, without acceleration, for the petition performance to 60 days after the entry of the order of relief. greater of one year, or 15 percent, not to exceed three years, of 6 11 U.S.C. § 365(d)(4). the remaining term of such lease, following the earlier of: 7 11 U.S.C. § 365(d)(4)(B)(i). 8 11 U.S.C. § 365(d)(4)(B)(ii). (i) The date of the filing of the petition; and 9 One may ask why a debtor would not simply assume the lease before the 120-day deadline and then later reject the lease if it finds the lease to be cumbersome. The reason is that if a lease is both (ii) The date on which such landlord repossessed, or the tenant assumed and rejected post-petition, such post-petition damages are elevated from a general unsecured claim to an administrative expense claim in the bankruptcy. In re Multech Corp., 47 B.R. surrendered, the leased property; plus 747, 750 (Bankr. Iowa 1985); 11 U.S.C. § 365(g)(2). The landlord’s administrative claim must be paid in full before a tenant can confirm its proposed Chapter 11 plan. 11 U.S.C. § 1129(a)(9). (B) Any unpaid rent due under such lease, without acceleration, on the 10 11 U.S.C. § 365(g)(1). 11 earlier of such dates. 11 11 U.S.C. § 502(b)(6). For example, for any lease term with 20 years or more remaining, the cap will be three years’ rent. If the remaining lease term were 10 years, the Foley Attorneys Receive Vision Award for Urban cap would be 18 months’ rent. Redevelopment Efforts Assignment of Commercial Leases to Third Foley’s Milwaukee office recently received the Vision Award at the 8th Parties by the Tenant Annual Milwaukee Awards for Neighborhood Development Innovation Commercial landlords often engage in rigorous screening of commercial (MANDI), presented by the Local Initiatives Support Corporation (LISC). tenants. However, the happenstance of a tenant’s bankruptcy could result LISC is the largest nonprofit in the country dedicated to urban in a landlord being left with an entirely new tenant without ever consenting redevelopment. Each year, the organization presents the MANDI awards to to such assignment. The Bankruptcy Code permits a tenant to assign its honor nonprofit community groups and their partners involved in revitalizing lease to any third party so long as (1) the tenant takes all steps necessary Milwaukee neighborhoods. The Vision Award specifically recognizes a to assume the lease and (2) the assignee provides adequate assurance of group that has shown strong commitment and leadership in transforming future performance regardless of whether or not there is a default. the community through financial contributions or in-kind support to local Significant incentive exists for a tenant to assign the lease where the development efforts. commercial space is in high demand. For example, a tenant may currently Foley was honored for dedicating pro bono hours to complex projects in be paying the landlord $10,000 a month for commercial space. The tenant the community, including redevelopment of the Menomonee Valley, a files for bankruptcy and assigns the lease to a third-party for $15,000. The 1,200-acre brownfield located adjacent to downtown Milwaukee; assistance tenant — not the landlord — captures the $5,000 a month profit, to the 30th Street Industrial Corridor; completion of the Hank Aaron State regardless of the terms of the lease. Trail, which links the Milwaukee lakefront with the near west side of the Conclusion city; and development of the new Discovery World at Pier Wisconsin. Even the most diligent of commercial landlords may find themselves in the Foley attorneys Michael W. Hatch, Hugh J. O’Halloran, Bruce A. Keyes, throes of bankruptcy. While this article provides a general outline of some Sarah A. Slack, and David M. Loring were honored at the award ceremony. of the key issues facing commercial landlords, other specific The firm also was recognized for its adoption of a firm-wide policy to considerations exist, including possible pre-bankruptcy termination of the support and encourage pro bono work. In 2005, the firm logged more lease and related remedies a debtor may seek against the landlord for than 30,845 pro bono hours, more than doubling its 2003 total.

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American Girl Relocating to array of premium-quality books, dolls, clothes, ABOUT FOLEY Chicago’s Water Tower Place toys, and accessories. Today, American Girl is a wholly-owned subsidiary of Mattel, Inc., the Foley & Lardner LLP provides the full By Donna J. Pugh world’s leading toy company as well as one of range of corporate legal counsel. American Girl, one of the nation’s top direct the country’s most respected brands. marketers, children’s publishers, and Our attorneys understand today’s most experiential retailers is moving its renowned In 1998, the company opened American Girl complex business issues, including American Girl Place flagship store to Water Place Chicago — a retail and entertainment site corporate governance, securities Tower Place, widely recognized as one of the located in the Gold Coast shopping district off of Michigan Avenue — as a way to bring its enforcement, litigation, mergers and premier shopping destinations in the world and one of the foremost tourist attractions in the products and stories and the values they acquisitions, intellectual property city of Chicago. Water Tower Place is owned represent together in one special place. From counseling and litigation, information and managed by General Growth Properties, the moment the doors opened, American Girl technology and outsourcing, labor and the nation’s second largest mall Place Chicago has been praised as one of the premier models for experiential retail in the employment, and tax. The firm offers owner/operator with over 200 regional shopping malls totaling over 200,000 million country. Almost overnight, the store’s signature total solutions in the automotive, square feet of retail space. The move to Water berry-colored shopping bags flooded Michigan emerging technologies, energy, Tower Place provides American Girl with Avenue as well as city hotels, buses, and trains entertainment and media, food, golf opportunities for growth such as offering a fun and today are a widely recognizable Chicago icon. The success of the Chicago location paved and resort, insurance, health care, new experience for girls, expanding the Cafe to include a private dining area, and, ultimately, the way for two additional American Girl Place life sciences, nanotechnology, and serving more customers. The size and layout flagship locations. American Girl Place New sports industries. of the new store also will provide a more York opened in 2003 along Manhattan’s efficient store layout with additional legendary Fifth Avenue, and American Girl Place Los Angeles opened in 2006 at The Foley.com entrances, underground parking access, and increased street-level visibility, Grove, L.A.’s renowned outdoor shopping and contributing to a more pleasant shopping entertainment destination. experience for customers. Since purchasing Water Tower Place, General Foley & Lardner LLP Legal News: Real Growth has worked diligently to enhance the Estate is intended to provide information Donna Pugh, who leads Foley’s National Land Use and Entitlements Sub-Group as a part of retail mix and has added over 80,000 square (not advice) about important new feet of new and existing retail concepts, many of legislation or legal developments. The the Real Estate Practice and her land use team, assisted American Girl and General which have entered the Chicago market for the great number of legal developments first time, adding an element of uniqueness and does not permit the issuing of an update Growth Properties in obtaining necessary governmental approvals to accommodate creating a special shopping experience for for each one, nor does it allow the Chicago shoppers. issuing of a follow-up on all subsequent American Girl’s signature berry awnings and developments. other needed physical changes. Foley The move to Water Tower Place has been met lawyers, Blaine R. Renfert, Elizabeth L. Corey, with enthusiastic support from the Greater North If you do not want to receive further Michael G. Laskis, Michael B. Van Sicklen, Michigan Avenue Association, Streeterville issues of Legal News, please e-mail Christopher C. Cain, and Mark J. Diliberti Organization of Active Residents, and local [email protected] or contact Marketing at have provided legal services to American Girl residents at a series of public presentations and Foley & Lardner LLP, 321 N. Clark in the past in the areas of leasing, litigation, community meetings. The store is anticipated to Street, Suite 2800, Chicago, IL 60610 corporate, and intellectual property. In open in fall of 2008. We look forward to seeing or 312.832.4500. addition, Mark Mansour and Sara A. Key the berry-colored bags and awnings gracing represent Mattel, American Girl’s parent Water Tower Place on Michigan Avenue. company in regulatory and public policy work.

Since the first catalogue debuted in 1986, American Girl has devoted its entire business to celebrating girls ages three to 12 through an