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Bankruptcy Provisions in Commercial Leases

Bankruptcy Provisions in Commercial LeasesLet’s examine what you need to know about bankruptcy provisions in commercial leases. Each property is unique and every relationship has its own contours that will drive the path of commercial lease negotiations. While a lease cannot account for or predict every potential scenario in the course of a commercial landlord-tenant relationship, landlords can put themselves in a better position to weather a tenant bankruptcy by understanding the bankruptcy landscape, including which provisions will be enforced and which provisions will be ignored by bankruptcy courts.

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Most landlords know that commercial bankruptcy cases generally take one of two forms: chapter 7 or chapter 11. In both types of cases, the automatic stay applies. In both types of cases, the commercial lease can be assumed, assigned or rejected within a finite period of time. A chapter 7 case is a liquidating case, while chapter 11 cases are typically reorganizations.

A tenant filing bankruptcy under chapter 7 will cease doing business. There, the court appoints a chapter 7 trustee to gather and liquidate assets and to distribute the proceeds to creditors. While the debtor tenant in a chapter 7 case is unlikely to continue the lease, the trustee may sell/assign a valuable lease to a third party. Negotiations in a chapter 7 case take place with the chapter 7 trustee, rather than with the debtor tenant.

On the other hand, a tenant filing a chapter 11 bankruptcy generally continues operations as a “debtor-in-possession.” The chapter 11 case typically culminates in a plan of reorganization, through which the debtor will outline its plans to fund payments to creditors, restructure debt and continue operations as the entity emerges from bankruptcy. Often, chapter 11 debtors seek to shed debt by rejecting above-market leases or leveraging the right to assume and reject leases by extracting rent concessions from landlords as a condition to lease assumption. Absent unusual circumstances, the court will not appoint a trustee, thus negotiations take place with the debtor tenant.

While a tenant bankruptcy filing shifts the balance of power to the tenant, defensively drafted leases may allow the landlord to retain some control and negotiating advantage after the filing of a bankruptcy.

7 Bankruptcy Provisions in Commercial Leases

(1) Tenant bankruptcy triggering lease termination
Bankruptcy provisions in commercial leases that would terminate a lease or modify other rights of a bankrupt party upon the filing of a bankruptcy petition are known as ipso facto clauses and are unenforceable under the Bankruptcy Code. Bottom line: Don’t waste your leverage trying to incorporate or keep an ipso facto provision in the lease.

(2) Waiver of the automatic stay.
The filing of a bankruptcy petition automatically triggers a stay of all activities to collect a debt, including efforts to obtain possession of property. To avoid the delay associated with the  imposition of the stay, consider including a provision requiring the tenant to waive the protection of the automatic stay or a waiver of the right to contest a motion by the landlord for relief from the stay. The remedy, if enforced by a court, allows a landlord to obtain relief much sooner than it would otherwise be entitled, particularly because courts are reluctant to grant stay relief in the early days of a bankruptcy case. Bottom line: Whether this provision is worth fighting for depends on your jurisdiction. Not all courts will enforce a pre-petition waiver of the stay, and even if they will, the waiver will generally not be “self-executing”. The blessing of the court is needed. Therefore, to avoid the imposition of sanctions that accompany a violation of the stay (or the voiding of stay-violating activities), landlords with waivers in a lease should consult with counsel on filing the appropriate motion with the bankruptcy court before pursuing eviction or collection activities.

(3) Adequate Assurance Definition.
Under the Bankruptcy Code, in order for a bankrupt tenant to assume a lease, it must provide the landlord adequate assurance that it will meet its future lease obligations. The Bankruptcy Code does not define “adequate assurance”, but the parties can define the concept in the lease to narrow the issues in bankruptcy court litigation. Adequate assurance provisions often require the tenant provide assurances as to (i) the source of future rent, including that any assignee is similarly situated, financially, to the tenant at the time the lease was signed, (ii) the stability of the percentage rent, if applicable; and (iii) non-disruption to the tenant mix in the center or complex. Bottom line: A lease containing specific understandings of ambiguous bankruptcy concepts will carry greater weight with a court interpreting a tenant’s post-petition obligations to its landlord.

(4) Shopping Center Provisions.
While bankruptcy courts do not favor limitations or conditions on the assignability of a lease, shopping center leases receive special treatment and, as a result, shopping center landlords have greater leverage in post-petition assignment negotiations. Therefore, if a property can reasonably be considered a shopping center, including a provision indicating that the property is a shopping center may afford a landlord with additional leverage and protections. Any shopping center lease should require that any assignee of the lease in a bankruptcy adhere to exclusive use (or other use restrictions), co-tenancy and tenant mix requirements. Bottom line: Ensure that any
shopping center lease contains provisions that protect the future viability and maintain the integrity of the shopping center if a tenant lease is assumed and assigned in bankruptcy.

(5) Security.
Cash may be king, but, generally, security deposits become property of the debtor’s estate once a bankruptcy petition is filed, limiting the setoff rights of a landlord and requiring motion practice in the bankruptcy court. A letter of credit, coupled with a lease provision allowing the landlord to draw upon it after default and without notice to the tenant, generally falls outside of “property of the estate” and therefore provides more ready access to cash to a landlord whose tenant has filed for bankruptcy. Bottom line: Securing the tenant’s obligations under the lease by collateral that falls outside the umbrella of “property of the estate” puts the landlord in a better position to recover costs when dealing with a tenant in bankruptcy.

(6) Guarantors.
A corporate parent or affiliate guaranty provides additional security for the tenant’s lease. Frequently, however, that guarantor often files bankruptcy at the same time as the tenant, and the landlord’s claim against the guarantor becomes one of many unsecured claims that will receive cents-on-the-dollar recovery. Personal guaranties from tenant equity holders may provide more protection because of the “skin in the game” and a reluctance of many individuals to file personal bankruptcy. Bottom line: The newer the business or the more limited financial history of your tenant, the more compelling a case for obtaining personal guaranties.

(7) Forecasting Trouble.
Bankruptcy provisions in commercial leases that require the submission periodic financial statements, balance sheets and cash flow statements from a tenant and any guarantors will allow a landlord to monitor the performance of its tenant. Leases containing financial covenants provide a mechanism for a landlord to call a default if financial performance declines. Having a heads-up to financial distress can allow the landlord to exercise remedies quickly and potentially in advance of any bankruptcy filing. The automatic stay does not apply to leases terminated pre-petition, so moving quickly to terminate in a distressed situation may give the landlord a valuable edge in regaining possession of the property outside of the bankruptcy court. Bottom line: The more you know about your tenant’s finances, the better you can react to a deteriorating situation, whether by exercising remedies or bolstering the security for the tenant’s obligations under the lease.

The contents of this article are for informational purposes only and none of these materials is offered, nor should be construed, as legal advice or a legal opinion based on any specific facts or circumstances.

Have questions about about bankruptcy provisions in commercial leases?

 

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Office Decommissioning – The Overlooked Cost of Moving

office decommissioningConsidering office decommissioning and relocation? Here’s a secret that no one ever tells you about moving – the bulk of your relocation costs are NOT transitioning your belongings to the new space. The fact is, office decommissioning is a significant factor in your budget, sometimes adding up to 3-5 times that of the actual relocation itself.

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All too often, clients miss the not so obvious “other move” when it comes to their office relocation. Clients split their time and attention operating their core business while also focusing on the “new” space and the endless questions, details, and decisions that are required to get that space ready to unveil. The “old” space, as well as the furniture in it, is often overlooked. If you think you can just leave the furniture and the cleaning for the landlord, you are mistaken!

The problem is that neglecting to properly decommission the old office space leaves you exposed to a wealth of unnecessary costs. The majority of commercial leases contain very specific requirements as to how the old space needs to be turned back over to the landlord. If not, it’s your deposit that hangs in the balance, just waiting to satisfy those obligations you signed off on in your original lease long ago. The removal of unwanted furniture and equipment can be an expensive undertaking, especially if not handled properly, and your landlord is well within his rights to apply your deposit to those costs.

Most commercial leases require that the occupied space be left “broom swept.” This means that all contents, freestanding furniture, workstations, office/IT equipment, shelving, racking, etc., must be completely removed, and all floors left cleared of debris and vacuumed. That also means following through on tiny details like removing any data/IT cabling that you’ve added while in residence. Overall, you need to return the space back to its original condition prior to your occupancy. Your lease should spell out the specific requirements and standards you will be held to.

office space decommissioningSo how do you protect your deposit? You need a detailed plan and a schedule! The easiest way to satisfy your lease obligations and get your deposit back is to consult a professional who is well-versed in handling the office office decommissioning process. When you partner with the right commercial removal company or transition management company, they can help you properly navigate and negotiate your exit. Most standard moving companies aren’t experienced enough to guide you through this process, and handling it yourself elevates your “soft cost exposure.” Most people over value what they have, don’t fully understand what they’re required to do, and then end up running out of time. The reality is that there is a very tight timeline when you move and the space needs to be vacated. Why wait on a potential buyer to purchase unwanted assets, when it elevates your risk of exceeding that timeline and paying a costly penalty to your former landlord? You need to understand the cost of the distraction to your core business while focusing on something that is only likely to yield a marginal return.

When you value the assets you will not be moving to your new space, factor in the time it takes to liquidate them. It’s often best to hire an expert to advocate for your bottom line, and help you sort it all out in an efficient and expeditious manner. There are three outcomes in an office decommissioning: net positive, net zero, and net negative. To achieve “net positive,” the liquidation of furniture and/or equipment yields a positive cash return and is clearly the optimal outcome to strive for. To attain “net zero,” you can choose to donate contents to a local charity for re-purpose, or have a third-party company remove them at no cost. While you don’t make any money on the transaction, you save the potential cost of having to remove the contents yourself. For those items that simply don’t have much or any value, and need to either be recycled or disposed, you’ll find yourself in a “net negative” position. Although there’s a nominal return for recycled items, the cost for disposing valueless items leaves you with a fee that an office decommissioning expert can help minimize. You don’t want to incur unnecessary storage costs for assets that won’t garner you a net positive return on that investment.

Quite frankly, there is an enormous difference between a transition management expert and a standard moving company. Before you sign with a relocation company, discuss with them the office decommissioning services that they provide. Pin down the price for the services that you need, and compare that cost with hiring various removal providers. Most commercial movers overlook office decommissioning, and this portion of the job can cost many times your relocation fee depending on how much of your existing furniture you will be taking to your new space.

Once you have the transition team in place, establish a facility decommissioning plan and lock in hard dates and deadlines. Make sure that the company is reliable, and that the personnel have the necessary skills to execute the plan. Often times, it is not worth the risk of going with the vendor with the lowest bid, as the cost for additional “buy back days” at your old space can quickly eclipse those cheap vendor savings.

So what is the takeaway from all of this? Simply that companies that focus all their time and effort on “hard costs” of relocation will be blindsided by the much more important “soft costs” of the move. A transition management expert minimizes your company’s exposure to lost revenue by reducing the distraction to your core business and curtailing downtime. Consult with an expert, and the savings on the office decommissioning will more than likely pay for the actual relocation.

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ABOUT ARGOSY MANAGEMENT GROUP, LLC
Argosy Management Group (AMG) is a leader in office relocation and logistics project/move management. AMG services companies throughout the U.S. and worldwide. AMG delivers a wide range of comprehensive services: move management and transition planning, space planning and furniture needs, office and industrial relocation and liquidation, storage solutions and asset management, furniture disassembly and installation, and I.T./data center relocation.

Visit www.argosymg.com

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Lease Security Deposits in New Jersey

Lease Security Deposits in New Jersey (PDF)

By Stacy L. Asbell, Esquire Hyland Levin LLP December 18, 2015
Generally, a lease security deposits in New Jersey are a landlord’s security for the tenant’s performance of its obligations under the lease. In the event the tenant does not uphold the tenant’s responsibilities under the lease, the security deposit can be a remedy for the landlord. In New Jersey, there are strict rules for the collection, retention and return of security deposits held by landlords in connection with residential leases. Unlike residential leases, security deposits in commercial leases are a matter of negotiation between the parties.

Commercial Security Deposits in New Jersey

The amount of the security deposit in commercial leases can be influenced by many factors including the amount of rent being paid by the tenant, the amount of up-front investment to be made by the landlord and the financial strength of the tenant and any guarantors. The parties should consider the following in reviewing the security deposit in a lease:

• Will the landlord be obligated to keep the security deposit in a separate account? Practically, most commercial landlords want flexibility to comingle the security deposit with other accounts.

• Will the security deposit be maintained in an interest bearing account and will the tenant be entitled to the interest? Commercial landlords take the position that the tenant is not entitled to the interest on thesecurity deposit if it is maintained in an interest bearing account.

• What is the security deposit intended to protect? Commercial landlords want the right to use the security deposit to secure any and all tenant obligations under the lease. Alternatives include restricting the use of the security deposit to secure only monetary terms, like rent or damage to the leased premises. Tenants should be wary that broader coverage of all claims by the security deposit will permit a commercial landlord to use the remedy as a means of “self-help.”

• Will the application of the security deposit to a tenant default cure the default? In negotiating the security deposit, commercial tenants may want to include provisions that the application of the security deposit will be considered the landlord’s election to cure the tenant default and therefore, the landlord is then prohibited from terminating the lease or evicting the tenant.

• Will the tenant be required to replenish the security deposit in the event the Landlord applies all or a portion of the security deposit to a breach? Consistent with the application of the security deposit to cure a breach, commercial landlords will require the tenant to immediately replace the funds previously applied. This can result in multiple breaches under the lease in the event the tenant defaults and then fails to replenish the deposit.

• What will be the form of the security deposit? Most security deposits will be in the form of cash security or a letter of credit. While letters of credit can be adequate security, the landlord will want to consider: (i) what bank is issuing the letter of credit and its creditworthiness; (ii) whether the letter of credit is irrevocable; (iii) whether a partial draw on the letter may be made; (iv) the term of the letter of credit, which should extend for a period beyond the lease expiration; and (v) what documentation and acts are required by the bank to release the money to the landlord. Letters of credit also have an added benefit as they are not considered part of the tenant’s estate in the event the tenant declares bankruptcy. This means that, unlike the cash security deposit, the letter of credit is not subject to restrictions of the bankruptcy automatic stay.

• Will any portion of the security deposit be released during the term of the lease? Some tenants are able to negotiate “good boy” provisions allowing a portion or all of the security to be released if all payments to the landlord are made on time for a set period. For example, if all rent payments are timely made for two years, half of the security deposit may be returned to tenant.

Residential Security Deposits in New Jersey

Unlike commercial leases, the security deposit in a residential lease is governed by the Security Deposit Law, NJSA §46:8-19 et seq. The Security Deposit Law applies to the rental of all premises used for dwelling purposes pursuant to a lease, contract or license except owner occupied premises with not more than two rental units. Unlike commercial leases, where the security deposit provisions are negotiated, residential landlord are limited by the Security Deposit Law to the following:

• The landlord may not collect more than 1½ times the monthly rent as security.

• If the residential Landlord is receiving deposit money from ten (10) or more units, the landlord must invest the money in an insured money market or deposit the money in a variable rate account at a state or federally chartered bank. Residential landlords receiving deposits for less than ten (10) rental units are required to deposit the money in a state or federally chartered bank in an account bearing interest on
time or savings deposits. Landlords of seasonal rentals (rentals for a term of 125 days or less by a person with a permanent place of residence elsewhere) are not required to comply with the Security Deposit Law investment requirements.

• Interest on the deposit belongs to the tenant.

• Residential landlords are not permitted to commingle the deposit money with other accounts.

• Residential landlords are required to give each tenant a statement notifying the tenant of the location of the security deposit within 30 days of receipt of the deposit. In the event the landlord fails to notify the tenant of the location of the deposit, the tenant may require that the security deposit plus 7% interest per year be applied toward any rent due and owing as a penalty.

• Residential landlords are required to return the tenant’s security deposit within 30 days after termination of the lease along with the tenant’s portion of the interest.

Security deposits are typically assigned in the event of the sale of the leased property. The new owner should be responsible to each tenant for the full amount of the tenant’s deposit, and in the residential setting, the new owner will be responsible whether the new owner is the assigned the security deposit or not at closing. Residential landlords need to be careful to comply with these rules at lease commencement and on an ongoing basis.

Security Deposits in New JerseyStacy L. Asbell, Esquire: Hyland Levin LLP
www.hylandlevin.com

Practice Areas:
– Transactional Real Estate and Finance
– Real Estate Leasing
– Estate Planning
– Estate Administration
– Property Taxation

 

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