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Let’s look at how a temporary change to the bankruptcy code protects landlords. The Consolidated Appropriations Act of 2021 (CAA), signed into law on December 27, 2020 provides money for governmental departments, coronavirus stimulus to individuals and businesses, but also made a temporary change to the bankruptcy code. Some of those amendments directly affect the rights of landlords of commercial properties.
Since the pandemic started, landlords have been working with their commercial tenants by reaching deferral and waiver arrangements for payment of rent in arrears. Landlords are concerned that if their tenants filed a bankruptcy petition, payments made outside the ordinary course of the lease could be recovered by the bankruptcy estate, if the trustee brought a lawsuit to recovery of those payments under Section 547 of the Bankruptcy Code. Sections 547 and 550 provide for the avoidance and recovery of payments made on or within 90 days before the debtor filed for bankruptcy or one year if such transfer was to an insider, known as the preference period.
Under the CAA landlords have temporary protection from preference and claw back litigation. The safe harbor is geared toward encouraging landlords to work with their struggling commercial tenants, reaching agreements on the payment of rent without the fear of having to turn over those payment to a bankruptcy estate. To qualify, the payment arrangement should have been entered into on or after March 13, 2020, and the payment arrangement should not include, fees, penalties, or interest in an amount greater than what the tenant would have if paid on time and in full.
Landlords should also be prepared that if a tenant does file for bankruptcy, Section 365(d)(4) allows additional time for debtors to assume, assign, or reject nonresidential real property leases. Under the CAA, a Chapter 11 debtor has an initial 210 days to make a determination, and a 90-day extension provision with landlord written consent. However, debtors will still be required perform all of their obligations under the lease in a timely manner, unless the court directs otherwise.
Since these amendments will sunset on December 27, 2022 unless extended, it is important to understand the developments in case law and provisions of the change to the bankruptcy code. Our professionals can assist you in navigating the new rules and how they can impact your rent collection actions.
This e-alert is provided by Hyland Levin Shapiro LLP as a general summary of the topics discussed; it does not replace the need to consult with a legal professional and is not intended to be a substitute for competent professional advice, including any advice regarding the effect of the Consolidated Appropriations Act of 2021 on your particular business. If you have any questions about the provisions summarized above, please contact Angela L. Mastrangelo, Esquire at email@example.com or 856.355.2989.
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.
Signed into law by President Trump last Friday, the CARES Act is designed to provide assistance to American workers, families, businesses, municipalities and health care systems through an over $2 trillion stimulus package. Given the enormous reach of the bill, its impact on commercial real estate, and in particular landlords and creditors, is extensive. Here are some important highlights of the Coronavirus Economic Stabilization Act of 2020 as it pertains to commercial real estate:
What support does the CARES Act provide?
The Act provides direct support to multifamily properties in the form of forbearance relief for those with federally backed loans. Section 4023 of the Act specifies that multifamily borrowers with federally backed multifamily mortgage loans experiencing financial hardship due to COVID-19 may submit a request for forbearance to the borrower’s servicer affirming that the multifamily borrower is experiencing financial hardship as a result of the COVID-19 crisis. Servicers should provide the forbearance for up to 30 days to those multifamily borrowers showing such financial hardship, which forbearance may be extended for two additional 30 day periods. By availing itself of the forbearance under Section 4023 of the Act, a multifamily borrower may not, during the forbearance term, evict or initiate eviction proceedings against a tenant solely for nonpayment of rent or other charges and may not charge any late fees, penalties or other charges to such tenant for late payment of rent. Likewise, multifamily borrowers receiving forbearance may not issue a notice to vacate to a tenant during the forbearance, nor require a tenant to vacate a dwelling unit earlier than 30 days after the date such tenant is provided with notice to vacate. Federally backed multifamily mortgage loans include those purchased or securitized by Freddie Mac and Fannie Mae, making this form of relief available to more than 27,000 properties nationally. The FDIC has also encouraged banks to consider short-term mortgage forbearance for multifamily borrowers facing reduced revenue streams as a result of the COVID-19 crisis.
More generally, the CARES Act supports the commercial real estate industry by providing income assistance to residential tenants and consumers and liquidity, in the form of loans and other relief, to commercial tenants. Making direct payments and providing enhanced unemployment benefits to citizens will help stabilize employment and strengthen residents’ ability to make rental payments during the COVID-19 crisis. Smaller commercial tenants may be able to secure funds for essentials like paying rent, mortgages, utilities and payroll through expanded SBA loan programs.
What actions are restricted by the CARES Act?
The legislation places temporary moratoriums on the ability to foreclose on federally backed mortgage loans and evict residential tenants from covered properties, which include properties that have a federally backed mortgage loan or federally backed multifamily mortgage loan, in addition to those participating in other federal housing programs. Section 4022 of the Act allows a borrower with a federally backed mortgage loan experiencing financial hardship due to the COVID-19 crisis to request forbearance for 180 days, which relief may be extended an additional 180 days. Servicers are to provide the forbearance to requesting borrowers with no documentation required beyond the borrower’s attestation to the financial hardship caused by the COVID-19 emergency, and with no fees, penalties or interest charges beyond the amounts scheduled or calculated as if all contractual payments had been made on time and in full. Servicers of federally backed mortgage loans are also barred from initiating foreclosure, moving for a foreclosure judgment or order of sale, or executing a foreclosure-related eviction or sale for at least 60 days beginning March 18, 2020. Under Section 4024, a 120 day moratorium effective from enactment of the Act was placed on actions to recover possession of a covered dwelling from a tenant for nonpayment of rent or other charges. Residential landlords may not require a tenant to vacate a covered dwelling unit earlier than 30 days after providing the tenant with such notice to vacate, nor issue a notice to vacate during the 120 day period.
What is the latest from New Jersey and Pennsylvania?
Although ever-changing, like everything involving the COVID-19 crisis, landlords and creditors must also be aware of new legislation and current executive and judicial orders issued at the State level. As of this writing, below is the latest information on eviction and foreclosure related limitations in Pennsylvania and New Jersey:
Pennsylvania – On March 16, 2020, the Pennsylvania Supreme Court declared a statewide judicial emergency effective until April 14, 2020. On March 18, 2020, the court made clear that during the judicial emergency, no eviction, ejectment or other displacement from a residence based on failure to make payment is permitted. This appears to only apply to residential/consumer matters and not commercial matters (though arguably a personal guaranty of a commercial mortgage may fall into this category). Pennsylvania state courts are currently closed to the public for non-essential functions through at least April 3, 2020. All time calculations and deadlines relevant to court cases or other business are suspended through April 3, 2020.
New Jersey – On March 19, 2020, New Jersey Governor Phil Murphy signed Executive Order No. 106, which imposes a moratorium on removing individuals from their homes via eviction or foreclosure proceedings. The Governor has asked that financial institutions holding residential or commercial mortgages, equity loans, lines of credit or business loans implement a process to work with the borrowers to avoid foreclosure or default arising out of the financial hardships caused by the COVID-19 pandemic, or any government response thereto. On March 28, 2020, Governor Murphy announced a mortgage payment relief initiative for New Jersey homeowners approved by Citigroup, JP Morgan Chase, U.S. Bank, Wells Fargo, Bank of America and over 40 other federal and state-chartered banks, credit unions and servicers offering (i) mortgage payment forbearance of up to 90 days to borrowers economically impacted by COVID-19, (ii) a moratorium on foreclosure sales or evictions of at least 60 days, (iii) relief from mortgage-related late fees and other charges for at least 90 days for borrowers requesting COVID-19 related assistance and (iv) restricting financial institutions from negative credit reporting for borrowers requesting COVID-19 related relief. He has also instructed residential landlords in the State to work with renters so they can remain in their homes, and warned that those who seek to evict tenants during this time will face stern consequences for violating the eviction moratorium.
What are the implications for residential and commercial landlords?
Given the eviction moratoriums presently in place and the importance placed by the CARES Act on allowing owners and renters to remain in their homes, multifamily owners who experience significant revenue declines may need to make use of the forbearance options or negotiate loan modifications or extensions with creditors. Commercial landlords will likely need to negotiate with both their tenants who are facing significant economic stress in keeping up with rent obligations and their lenders. In the current COVID-19 crisis, being proactive and initiating conversations is definitely preferred over the “wait and see” approach.Borrowers should review their loan covenants now, particularly for any material adverse change, force majeure and similar clauses; test any cash flow or financial covenants; and review any limitations on their ability to modify, cancel or amend leases, property management agreements or other key contracts. Commercial leases must be reviewed to confirm whether the COVID-19 crisis qualifies as a force majeure event or triggers common law doctrines of impossibility, impracticability and/or frustration of purpose which may be applicable depending on the jurisdiction. Co-tenancy, continuous operations, access, exclusive and other use restrictions may also be impacted as a result of State or local restrictions and orders being in effect, for example allowing dine-in restaurant tenants to convert to take-out only service.
Landlords should also take the following actions to strengthen their tenant and lender relationships and in anticipation of heightened lender diligence:
- Consider imposing new or additional health, safety and maintenance regulations and performing increased cleaning activities at the subject property, and develop an employee or critical staff contingency plan that can be shared with lenders
- Document all communications with tenants regarding the COVID-19 emergency and any rental payment obligations, but make clear no modifications, forbearance or waivers of any lease terms are approved until documented in a formal amendment or agreement
Eliminate unnecessary expenses and consider creative solutions to reduce marginal costs
- Develop a cash flow forecast that projects anticipated liquidity for 30, 60, 90 days based on stated assumptions and update the cash flow forecast with data as information becomes available
Review all business interruption, rent loss and similar insurance policies to determine whether insurance benefits are available
- In addition to the above steps, landlords and borrowers would be well served to educate themselves about the relief programs available to their tenants. Encouraging residential tenants to secure direct cash payments under the CARES Act and commercial tenants to consider these new loan programs providing funding for rent payments, should increase the probability that tenants will satisfy their rental obligations.
If you have any questions or to further discuss the impact of the CARES Act on landlords and creditors, please contact Lauren Beetle at 856.355.2913 or firstname.lastname@example.org or Julie Murphy at 856.355.2992 or email@example.com.
In light of COVID-19 and the evolving climate resulting therefrom, Commercial and Residential Landlords are being presented with difficult decisions necessitating quick response. Everyone agrees health and safety is the priority; however, both landlords and tenants are asking what their rights and obligations are as a result of this pandemic. We’ve heard the term force majeure used over the past week as it relates to enforcement of contracts, leaving both landlords and tenants wondering if COVID-19 is a force majeure event that reduces or even eliminates their respective rights and obligations under the lease.
Force majeure clauses are found primarily in non-residential leases and only occasionally in residential leases. Generally speaking, force majeure clauses excuse a party from certain contractual obligations when an unforeseen circumstance or event outside of their control makes performance impossible. Force majeure clauses attempt to provide the parties with certainty if/when an unforeseeable unknown event occurs. Many force majeure clauses specifically define the triggering events while others vaguely refer to unforeseeable events or are silent.
At present, there is uncertainty as to whether COVID-19 is an event if force majeure; however, actions taken by the state and local officials to shut down businesses and encourage or mandate shelter-at-home protocols arguably trigger the effect of typical force majeure clauses, especially if health-related disasters, like disease or pandemic, are called out specifically.
As a first step in determining if COVID-19 is a triggering event, the landlord and tenant must review the express terms of the lease to determine if a force majeure clause appears. Next, the parties must determine the scope and language of the clause — does it specifically include or exclude health-related events or is it silent on that issue? Of course, if there is no such clause at all, a different analysis must be made.
Assume a clause exists and would be triggered by the current pandemic. In its simplest form, the express terms of a force majeure clauses in residential and commercial leases will dictate the parties’ rights and obligations. Further depending upon the circumstances and the level of specificity of the meaning or definition of “force majeure” as used in an express clause within a lease, principles of equity may be invoked. Simply because a force majeure clause appears in the lease which seems applicable does not necessarily mean either party is excused from its lease obligations.
Courts may choose to exercise their equitable powers in determining whether this pandemic implicates a force majeure clause containing or impliedly containing an “act of God” clause which, once invoked, creates an impossibility of performance, a determination that performance is unreasonable, that the contract is voidable
The foregoing information was furnished to us by sources which we deem to be reliable, but no warranty or representation is made as to the accuracy thereof. Subject to correction of errors, due to frustration of purpose, etc. Courts focus on the foreseeability of the event and the connection between the event and the non-performance. An otherwise-defaulting party will have difficulty invoking the force majeure to excuse its contractual obligations. In short, with respect to COVID-19, an interpretation of a force majeure clause must be made to determine whether the party seeking to be excused is simply attempting to use the force majeure to get out of a contract that party no longer wishes to perform.
For leases without force majeure clauses, common law doctrines of impossibility, impracticability and/or frustration of purpose may still apply to excuse contractual obligations. Simple economic struggle will not be a triggering event; however, economic struggle resulting from unforeseeable events may be sufficient.
On March 18, 2020, the Pennsylvania Supreme Court ordered a temporary moratorium on residential nonpayment evictions in the Commonwealth until April 3, 2020. The Order specifies this moratorium was enacted because of the economic impact COVID-19 is having on residents. At present, neither the Court’s Order nor the Landlord-Tenant Act excuses tenants from their rental obligations; however, it is more than likely that this Order will be updated and revised as the pandemic spreads.
Although the Order does not provide for any current rental abatement, if a Landlord is unable to provide tenants with the full intended benefit of the Lease, the monthly Rent should be appropriately adjusted. Congress is also considering relief for the housing providers in addition to renter assistance. Housing providers are experiencing the same health, safety and economic concerns as renters, such as an inability to pay their mortgage, employee payroll and benefits, insurance premiums and tax obligations in the current environment. Congress has been asked to provide much needed relief to both landlords and tenants in the midst of this pandemic; therefore, subsequent updates on this topic are likely.
Force Majeure clauses are typically only enforced as expressly agreed by the parties, but the pandemic may continue to affect this general statement. Since the PA Supreme Court is already entering equitable orders related to residential nonpayment of rent evictions at the beginnings of the pandemic, it is safe to say the Order will be updated and further extended as the pandemic evolves, possibly even affirmatively ordering a rent holiday, partial or full abatement or deferrals.
Many Pennsylvania businesses have been ordered to cease operations as they are not classified as life sustaining; therefore, commercial landlords and tenants are faced with additional concerns. The current list of business deemed to be life-sustaining is listed here.
Commercial leases are controlled by contract law in Pennsylvania; consequently, the express terms of the lease will provide the primary source of guidance. While landlords should retain an open dialogue with tenants, they must also be careful to not promise accommodations they are not able or willing to provide.
We expect landlords to be empathetic during this pandemic, but we do not believe landlords have a unilateral obligation to “foot the bill” for these problems they did not create. Further, if landlords and tenants have any verbal communications regarding rent accommodations, landlords and their agents must be extremely careful to specify that the parties will not be bound by the negotiations and will only be bound when a subsequent agreement is reduced to written form and signed by all parties. Force majeure clauses may be applicable to COVID-19 because of the governmental and court orders forcing closure beyond the control of the landlord or tenant; therefore, landlords must carefully comply with any notice or other procedural requirements set forth in the applicable lease.
Tenants will likely attempt to use a force majeure clause, assuming one to exist in the lease, or seek equitable relief, to excuse their rental obligations; however, most commercial leases preclude the use of force majeure clauses to abate rent and/or terminate the lease even if the tenant is unable to access the leased premises and operate. The terms of each lease and the local jurisdiction’s administrative Orders will affect this. Moreover, if the tenant does not actually vacate the leased premises, Courts will also have to take into account whether it is equitable on either a short-term or long-term basis for the landlord to continue to provide shelter and to incur costs without any compensation, notwithstanding the current prohibition on residential evictions for non-payment.
Mandated closures, like those resulting from Governor Wolf’s recent Order, may require landlords to shut their facilities, which prevents tenants from accessing their premises, making performance impossible whether or not there is a force majeure clause. In cases where the lease does not expressly include a force majeure clause, the concept of impossibility of performance may further provide some protection to landlords as well as tenants.
Force majeure clauses in most commercial leases preclude commercial tenants from withholding rent following an “act of god.” It is inevitable that a commercial tenant will seek rental abatement/deferrals/rent holiday if it is unable to occupy and operate. While the applicable lease may not require the landlord to engage in negotiations, it may be in the commercial landlord’s best interest to get creative and provide short-term relief to struggling tenants rather than suffer the alternative of losing tenants for the long-term and incurring substantial litigation expenses attempting to enforce the lease as written to compel occupancy and/or collect rent. Creative options for negotiations include but are not limited to, temporary rent reductions, payment of percentage rent only (if a retail store remains open; note, however, that the retail stores which do remain open are often grocery stores, which one would expect will be doing substantial business and should not have a problem paying rent), CAM-only monthly payments, application of security deposit to unpaid rent, rent deferrals, temporary rent forgiveness, lengthening the lease term by a time equivalent to the rent deferral period or requiring personal guarantees of future rent payment.
Because nearly everything about COVID-19 remains uncertain and consistently evolving, neither landlords nor tenant should make an assumption that COVID-19 will be declared an event of force majeure. It is of the utmost importance for landlords and tenant to comply with any and all force majeure provisions in the lease, including but not limited to the notice provisions, which may be critical to protecting their respective rights once this pandemic ends. Understanding the rights and obligations of your lease is key to long-term success.
Further, all commercial landlords need to consult their insurance advisors and review the specific terms of their policies, including but not limited to business interruption insurance and rent loss insurance as implicated by this pandemic. Landlords should also recommend that each tenant consult with its insurers regarding the same. Certain states are considering passing legislation expressly prohibiting insurers from denying claims relating to the pandemic, but that hasn’t occurred yet.
We urge all landlords, both nonresidential and residential, to assure that there is a pandemic plan and potentially engage counsel to review all leases for the following purposes: creating an addendum applicable to all tenants in the event of default; review of all force majeure clauses and updating them to include diseases, epidemics, and/or quarantines; review any other applicable contracts with tenants, residents, and suppliers to ensure they understand their rights in the instance of a force majeure.
Many landlords are current experiencing vacant retail centers, malls and buildings. One may think your job gets easier because there are few (or no) tenants in your building, but nothing could be further from the truth. In fact, even if your building is completely vacant for now, there is still plenty of work that needs to be done.
Please make sure that your team considers the following:
• Make sure your HVAC system is running properly.
• It’s ok to reduce regular thermostat settings (perhaps 55 degrees for heating and 80 degrees for cooling), but don’t turn off completely – just don’t turn them off completely!
• Make sure your outside air and exhaust fans are running to keep the air circulating.
• Make sure someone if putting water in the “p-traps” – particularly in sinks and floor drains – to keep sewer gases from backing up into the space.
• Make sure someone from your team is walking every inch of the building every workday.
• He/she should be looking for potential issues – like leaks, unsecured doors, equipment left running, etc.
• Make sure exterior doors and, where operable, exterior windows are locked.
• Work with your tenants to shut off equipment that is not in use. Remember that equipment (like a copier) is still drawing power even when it is in the power-saving mode.
• Water that is sitting still in the plumbing system will develop biofilms – which can cause disease (including Legionella, pseudomonas, and mycobacterium).
• Make sure someone is running the water through the system every day.
• Consider working with an industrial hygienist to test the potable water before letting tenants back into the building. The very last thing you want – after going through COVID19 – is to have an outbreak of Legionella when the tenants return!
• Consider posting a sign with your contact information on exterior doors in case someone needs access to the building.
• If the building is truly vacant, consider posting security guards on-site to deter vandalism and theft. Or, consider installing remote access cameras so you can keep an eye on common areas and the exterior.
• Make sure the roof access is secured – to keep people from accessing the roof and from accessing the building from the roof.
• Consider closing the miniblinds – or at least putting them down and angling them to minimize solar gain (which will reduce energy consumption).
• Review your insurance policy and notify your insurance provider. Even if the closure is only temporary, there might be insurance requirements to consider.
• Make sure building systems (pumps, motors, elevators, etc.) are exercised/run on a schedule. When these pieces of equipment sit idle, they can degrade quickly.
We suggest that you and your teams, colleagues and tenants sign up to receive up-to-the-minute text alerts from the city communications system by texting the word COVIDPHL to 888-777.
Finally, the CDC (Center for Disease Control & Prevention) has provided advice and guidelines for Landlords in the pandemic, specifically that Landlords keep Tenants informed on best practices.
If you have any questions, please contact Kierstin Lange at firstname.lastname@example.org from Zarwin Baum Devito Kaplan Schaer & Toddy PC.
Let’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.
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.
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.
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?
Let’s look at 10 common commercial leasing mistakes and how to avoid them. Commercial leasing transactions are among the longest term contracts parties will ever enter into, yet many often take the cavalier attitude that “it is just a lease.” That lack of focus and attention to detail often leads to mistakes that can haunt the parties for years and waste valuable time and money.
Ten Common Commercial Leasing Mistakes and Suggested Tips:
1. Incorrect Names of the Parties
The parties’ names must be clearly and precisely listed but have errors a shocking number of times, as either the landlord’s name, the tenant’s name or both are often incorrect. These mistakes cast potential doubts regarding the validity and enforceability of the lease agreement and raise possible defenses. If you end up in such a situation, a lease amendment should be signed that expressly ratifies all of the lease terms and acknowledges the prior error(s). Avoid such situations by verifying the parties’ names by searching New Jersey and Pennsylvania corporate websites, which can be completed within a minute free of charge. Obtaining copies of filed certificates of incorporation, certifications of formation and the like will also help verify that the parties’ names are correctly shown. Further, a short form good standing certificate or a subsistence certificate can be obtained online in a few minutes at a nominal cost.
2. Parties No Longer Exist
Entities to lease transactions (whether landlord or tenant or their successors or assigns) may be dissolved. Thus, the parties should conduct basic due diligence and verify the facts on an ongoing basis. Obtaining good standing or subsistence certificates could be helpful in this regard. If, for example, a good standing certificate indicates that annual reports and related fees are overdue, that party should be compelled to file such reports and pay such fees to avoid being involuntarily suspended by the State. If a party has already been dissolved voluntarily or involuntarily, they should be required to get their “organizational house” in order, and then lease instruments can be signed.
3. Your Lease is Actually a Sublease
Tenants should consider obtaining title searches to verify ownership of the property by the landlord indicated in the lease documents, or at the very least by asking for copies of deeds, tax records and title polices from their landlords. Otherwise, a tenant may not know that its lease is actually a sublease, which is more common than one might think. If you are a subtenant and not a tenant, your landlord cannot grant to you any rights that do not exist under the master lease and, therefore, you cannot understand your rights unless and until you review the applicable master lease.
4. Authorized Parties Do Not Sign or Incorrectly State their Title
Only an individual authorized to bind an entity should be signing documents on its behalf, and the signer’s name and title should be clearly shown. Such basics are commonly disregarded and the parties simply assume that whoever has signed the lease is an authorized signer. You should consider requesting copies of Operating Agreements, Shareholder’s Agreements and applicable consents and resolutions to confirm that an authorized person is signing. The lease documents should also explicitly represent that the person signing this lease document on behalf of each party is duly authorized to bind such party. If an agent is signing on behalf of the landlord, ask for evidence of authority in the form of a signed agency agreement granting such powers. Finally, make sure that the title of the signer matches the type of entity that is being bound. General partnerships have General Partners; limited partnerships have General Partners and Limited Partners; corporations have officers (i.e. typically President, Vice President, Secretary and Treasurer) and limited liability companies most commonly have Managers or Managing Members.
5. Premises Size Not Indicated
The size of the premises should be indicated, especially when the lease document indicates a rental rate on a square foot basis or requires pass throughs based on a proportionate share of the building or center.
6. Blanks in the Documents
Do not leave any blanks in the documents. Aside from simply looking sloppy, such blanks may be crucial in terms of triggering contractual milestones (e.g. lease commencement date, rent commencement date, timing to complete landlord’s work and the timing for the tenant to submit plans and to open for business). In a worst case scenario, document blanks could give rise to questions and disagreements regarding enforceability.
7. Lender and Other Required Approvals Were Not Obtained
Landlord’s loan documents may require lender’s approval prior to entering into any lease or lease amendments, and it is easy to forget to obtain such approval. Landlords should reach out to their lender(s) as soon as the lease is agreed upon so that the deal does not get derailed by delays. Tenants should ask for evidence of such lender approvals and representations that all required third party approvals have been obtained (or are not necessary). The parties should also check for rights of first refusal (ROFR), rights of first offer (ROFO), use and building restrictions in leases granted to other tenants.
8. Unclear if Prior Tenant Parties and Guarantors Remain Liable After Assignment
Original tenant parties and guarantors often remain liable for lease obligations even after there has been an assignment of a lease, barring negotiated releases. However, such continuing liability is often unclear to the responsible parties, including tenants that sold their businesses. Lease assignment and consent documents should clarify the scope and extent of the parties’ liability.
9. Unexpected Zoning Board, Planning Board or Other Approvals
It is not uncommon for leasing parties to discover after signing that unanticipated approvals are needed (such as from the zoning board or planning board), which can delay occupancy by months or longer and result in significant expense. Signage and other approvals may also be necessary. Ideally, the parties would perform due diligence of the zoning code and obtain copies of prior approvals granted prior to entering into the lease, and then allocate their respective responsibilities, obligations and related costs between them.
10. Failure to Utilize Professionals
There is no such thing as a standard lease, and the parties must ensure that the documents being negotiated and signed reflect their mutual understandings. Landlords and tenants would be wise to utilize experienced and qualified professionals such as commercial real estate brokers with local knowledge to assist in the leasing process. They would also be prudent to choose an attorney with significant leasing experience, good judgment and a reputation for getting deals done.
A leasing transaction is one of the longest term contracts most parties will ever sign, typically lasting five years or longer. Some landlords and tenants take the attitude that “it is just a lease” (and therefore not a big deal) and do not pay requisite attention to the key basics of any contract, and those basic deal terms are wrong in an astonishing number of deals. The most common commercial leasing mistakes, such as incorrectly naming the parties, leaving blanks that potentially impact the rent commencement date and other key milestones and incorrectly stating a signer’s title are shockingly common. Landlords and tenants should take their time to get the deal as reflected in the lease documents precisely right, and avoid common mistakes such as those listed above, the majority of which can be avoided without significant expense by simply paying attention to the details.
Kenneth M. Morgan is an experienced leasing attorney licensed in Pennsylvania and New Jersey.
The contents of this article are for informational purposes only and none of these materials offered are, nor should be construed as, investment advice, legal advice or a legal opinion based on any specific facts or circumstances.
Commercial landlords often view franchisees in well-known franchise systems as attractive retail tenants. Leasing space to a franchisee, however, raises a number of unique issues and may require you, as a commercial landlord, to negotiate not only with the franchisee/tenant, but also the franchisor.
This article addresses the peculiar issues that may arise when your retail tenant operates a franchise. Site selection and continuity of operations are critical components for successful franchise systems. A franchisor, therefore, will often seek to maintain a level of control over the space occupied by its franchisee. In order to protect its interests in the “locational goodwill” that develops at a successful franchisee site, a franchisor will often insert itself into the landlord/tenant relationship. A franchisor does this in two common ways. First, the franchise agreement may require a franchisee to negotiate certain provisions into its lease. Second, a franchisor may seek to have a landlord execute a separate “lease rider”, which provides the franchisor with additional rights upon the franchisee’s default of its lease.
FRANCHISE SPECIFIC LEASE PROVISIONS
A standard franchise agreement will include a description of lease provisions that the franchisee is required to include in its lease in order for franchisor to approve its form. As a landlord, therefore, you should not be surprised to see a prospective franchisee tenant provide you with a list of franchise specific revisions to your proposed lease. Franchisor-mandated provisions for the lease commonly include:
1. A use clause limiting the permitted uses to the type of business permitted by the franchise agreement (i.e. the franchised concept only). The franchisor wants to know that the franchisee will not be selling items the franchisor has not specifically approved, nor assigning the lease, in bankruptcy or otherwise, to a party other than the franchisor or an approved franchisee.
2. A requirement that the lease term must be tied to the franchise agreement term. The franchisor wants to know that the franchisee will have a location to operate its franchised business during the term of the franchise agreement, and conversely it does not want its franchisee to have leased property without franchised rights to operate. Thus, the lease term and the franchise agreement term are to be co-terminous.
3. A clause confirming the franchisee’s right to use the franchisor’s marks and required signage package at the property, in order to maintain system uniformity. This provisions makes it clear that the landlord’s signage and other design restrictions will not preclude the franchisee from utilizing the franchisor’s mandated branding scheme.
4. A strict no subletting or assignment provision, except to the franchisor or its designee. This provision prevents an unauthorized sale of the franchisee’s business or the franchisee trying to avoid the franchise agreement’s non-compete provision.
5. A clause entitling the franchisor to take an assignment of the lease, at its option, upon franchisee’s default.
6. Language providing that the franchisor shall receive all notices of default, prior to eviction, and shall have right to cure. When a franchisor receives a copy of a notice of default sent to the tenant/franchisee, it can decide whether it will declare an event of default (a cross-default) under the franchise agreement – which is often an option for the franchisor.
7. A provision allowing the franchisor to enter the leased property upon termination of the franchise agreement in order to de-image the location so as to properly distinguish it from the franchise system. Upon termination of the franchise agreement, the franchisee is required to take down its signs and otherwise de-image from the franchised concept. If it fails to do so, franchisor needs to be able to cause the required de-imaging, without being guilty of trespass.
Despite the importance of the provisions to the franchisor, a franchisee will derive little benefit from these provisions, and in fact runs the risk of angering its new landlord (you) with the additional burden of negotiating these points. Therefore, the franchisee does not have a strong desire to push hard for these points. In practice, a franchisee will often negotiate its lease with you, present it to its franchisor for approval, and only then learn (be reminded) of the importance of the franchisorrequired provisions. Going back to the landlord at that point is an uphill battle for the franchisee. Like the franchisee, the landlord will often be disinterested in the franchisor’s requests. You will not want to further negotiate your “standard” form and specifically, will not want the administrative burden of sending notices and lease amendments to both the franchisee and the franchisor. Nor will you want to add time to cure periods. As a landlord, you need to weigh these burdens against the value of having a recognized franchise system and brand, likely with a strong track record marketing its locations.
Franchisors can live without many of the provisions listed above, but the collateral assignment (also known as a lease option agreement) is the one that really counts. Ideally, for a franchisor, the franchisee’s lease will be collaterally assigned to the franchisor. The collateral assignment acts as a promise by the franchisee to assign the lease to the franchisor in the event of default. This document, often known as a “Lease Rider” is a tri-party agreement; signed by each the franchisee, franchisor and landlord. Having the landlord and franchisor as signatories to the Lease Rider will confirm that the franchisor has a clear right to enforce the provisions against you, regardless of franchisee’s position, including as a debtor under a bankruptcy proceeding.
There are five main components of a well-drafted collateral assignment of lease for a franchisee:
• A clear expression that the agreement is for collateral purposes only and that the franchisor will not incur any liability, unless and until it takes possession and assumes the tenant/franchisee’s obligations.
• Upon a default under the lease (prior to eviction) or the franchise agreement, the franchisor has the option to take possession or assign the lease to another franchisee.
• The franchisor will receive copies of notices of default.
• The lease will not be modified without franchisor’s consent.
Upon expiration or termination of the lease, and in the event franchisor elects not to assume the lease, franchisor is granted the right to cause a de-imaging of the premises, without being guilty of trespass. Again, the only party who will push hard for these rights will be the franchisor. Other than for the purpose of “getting the deal done”, the franchisee will have little incentive to cause you, as landlord, to comply. The franchisee will usually want to save its negotiation chips for points directly in its favor. Similarly, the landlord will typically want flexibility with the space if the tenant is having problems. Accordingly, many landlords are unwilling to grant collateral assignments of leases. As in most cases, the respective leverage of the parties drives the issue.
Landlords counter these franchisor-required provisions by requiring that the franchisor guaranty the lease. A landlord will insist upon an agreement by the franchisor to cure all arrearages in full, prior to assumption. In response, a franchisor will argue that the arrearages for which it is responsible should be capped based on a time period (e.g., 45 days moving backwards from the date franchisor receives notice of default). Thus, the landlord, who may view additional notice parties as an administrative headache, will be motivated to send default notices to the franchisor before its tenant becomes too far behind in rent.
Landlords generally want to limit the transferability of the lease. For example, a landlord will permit assignment, without its consent, only to the franchisor, and not to another franchisee or other designee. No landlord wants a revolving door of failed franchisees. Often, a compromise is a franchisor guaranty for a limited period of time following an assignment.
Successful franchisors work hard to maintain a level of control over their valuable locations. Although it may seem like the franchisor is merely trying to exert its influence over the landlord/tenant relationship during lease negotiations, the franchisor has a vested interest in securing these protections. You, as landlord, will weigh the value of having a tenant offering recognized and popular goods and services in its center, together with a franchisor standing behind its operator, at one level or another, against the burden of these additional negotiations. The next time you are involved in a lease negotiation for a franchised unit, hopefully you will have a deeper appreciation for the franchisor’s motivation and be able to more effectively negotiate these franchise-specific issues.
Let’s explore fixtures, trade fixtures and who owns what at lease expiration. In order to facilitate a smooth transition between commercial tenants, it is important for landlords to understand their rights regarding items attached to their property. Generally, a lease will govern these rights. However, if the lease is silent on the issue, articles annexed to the property deemed “fixtures” must stay with the property, while articles deemed “trade fixtures” may be removed by a vacating tenant.
In New Jersey, a fixture is an object that “become[s] so related to particular real estate that an interest… arises under real estate law.” N.J.S.A. 12A:2A-309(1)(a). In contrast, an article may be considered to be a trade fixture if: (1) the article is annexed to the property for the purpose of aiding in the conduct of a trade or business exercised on the premises; and (2) the article is capable of removal from the premises without material injury thereto. Handler v. Horns, 2 N.J. 18, 24-25 (1949). As such, an important distinction between fixtures and trade fixtures is whether removal of the item will cause material injury to the premises. See e.g. GMC v. City of Linden, 150 N.J. 522, 534 (1997). In applying this test, courts infer that if removal of an article would cause material injury to the premises, the parties must have intended for the article to remain beyond the lease term. Id.
A typical conflict involving this nuanced distinction may involve a vacating tenant removing an item from the leased premises under the assumption that it was (1) attached to the premises for the purpose of conducting a trade or business; and (2) capable of removal without material injury to the premises. A landlord may dispute one or more of these assumptions, arguing that the article was not used in the conduct of business (that it was in fact attached to improve the structure) or is not capable of removal without material injury to the premises. Over the years, vacating tenants have attempted to remove countless items from leased premises, including air conditioning systems, irrigation systems, bolted down light fixtures and even circuit breaker panels, by arguing these items were trade fixtures. See e.g. In re Jackson Tanker Corp., 69 B.R. 850 (Bankr. S.D.N.Y. 1987).
However, it isn’t difficult to imagine a hypothetical where the traditional landlord and tenant arguments are reversed – that is, where the tenant argues that the article must remain with the property and the landlord argues that the tenant is responsible for its removal. This unusual fact pattern may especially arise where the tenant’s business is specialized in nature, and where equipment is not easily removed from the premises.
For example, Landlord rents out space to Tenant, who plans on operating a restaurant. The lease does not specifically address what does and does not constitute a trade fixture. Tenant plans on installing a walk in freezer and other specialized, complex systems. After several years of operating, Tenant declines to renew the lease, closes, and vacates the premises. Tenant removes the furniture, appliances not fixed to the premises and other items it deems to be trade fixtures and leaves the walk-in freezer infrastructure.
Tenant refuses to remove the walk-in freezer, arguing its removal will cause substantial damage to the premises. Unable to re-let the premises to a restaurant tenant, Landlord is left with a walk-in freezer occupying a substantial portion of the premises.
It is important that during the lease negotiation, landlords think carefully about the business their prospective tenant is in, the kinds of equipment the tenant will install and what will happen to that equipment upon termination of the lease. This same thought process applies when landlords receive requests for alterations. In the above hypothetical, Landlord could have avoided being left with a walk-in freezer and a less than desirable space if it addressed the issue during negotiation of the lease. A discussion with prospective tenants concerning the specific kinds equipment the tenant will install is always a good idea, followed by specifications and drawings for approval. Landlords are wise to reduce these conversations to writing, and specifically address each party’s expectations regarding the disposition of specific equipment when the lease inevitably comes to an end. As always, an ounce of prevention is worth a pound of cure.
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.
William F. Hanna, Esquire
Hyland Levin LLP
6000 Sagemore Drive, Suite 6301
Marlton, NJ 08053-3900
When a commercial tenant files for bankruptcy is not often a surprise to its landlord. Rent payments may arrive late, financial covenants may be missed, and the tenant may become generally unresponsive in the pre-bankruptcy period.
While the provisions of the bankruptcy code governing the treatment of leases are among the more complex in the code, this article provides guidance to landlords in navigating a commercial tenant’s bankruptcy and maximizing recovery on its claims.
Beware of the Automatic Stay when a commercial tenant files for bankruptcy
Upon learning a tenant files for bankruptcy , the landlord must abide the automatic stay. The automatic stay restrains actions to collect on a claim against the tenant, including enforcement of a judgment, creation of a lien, or otherwise attempting to recover any of the tenant’s property. The landlord may not, therefore, send a default letter or prosecute an eviction action. While limited exceptions to this general rule exist, a landlord should consult with counsel before taking any post-bankruptcy legal action against its commercial tenant. In some cases, the court may impose sanctions for willful violations of the automatic stay.
Monitor the case and gather pertinent documents when a commercial tenant files for bankruptcy
Carefully monitor a tenant’s bankruptcy case from the outset by reviewing all pleadings sent in connection with the case. Often, motions filed in the first days of a bankruptcy case set critical deadlines and tee-up for court approval mechanisms for funding the debtor through bankruptcy, including authority for the debtor’s use of assets (assets that may be subject to a landlord lien) during the course of the case. Pay special attention to the deadlines for filing proofs of claim and for filing proofs of rejection damages, each of which require affirmative landlord action to recover unpaid sums under the lease. Closely review any budgets filed by the tenant to confirm that the budget includes post-petition rent payments in the correct amounts. Consider retaining counsel to appear in the case, which will ensure that you receive prompt notice of events in the case and relevant deadlines.
Gather all documentation pertinent to the bankrupt tenant in order to readily assert claims in the bankruptcy case, including to support a motion for relief from the automatic stay if it becomes necessary. Ensure you have copies of the following:
• A fully executed copy of the lease, any amendments and guaranties
• Records of rent payments, both before and after the bankruptcy filing
• Records of maintenance obligations and payments
• Default correspondence
• Any property searches obtained showing liens created by the tenant
Disposition of the lease and payment of rent and other sums when a commercial tenant files for bankruptcy
Whether or not a commercial landlord desires to continue its business relationship with the bankrupt tenant, the bankruptcy code allows the debtor to exercise its business judgment to determine whether to assume (retain) or reject (terminate) an unexpired nonresidential lease.
If the tenant assumes the lease, it must make the landlord whole for any unpaid rent and any pecuniary losses stemming from the defaults under the lease. The tenant must also provide to the landlord “adequate assurance” of its future performance under the lease. With respect to shopping center leases, the bankrupt tenant must meet a higher standard than other tenants in order to assume the lease. The shopping center tenant must show: (a) that the debtor, as reorganized, or its assignee, will have at least the same ability to pay the rent as the initial lessee; (b) that any “percentage rent” will not substantially decline; (c) that the assumption of the lease will be subject to the all of the provisions of the lease, including provisions relating to radius, location and/or exclusivity; and (d) that the assumption thereof will not breach the provisions of any other lease, financing agreement or master agreement relating to the shopping center, nor disrupt the tenant mix in the shopping center.
If the tenant rejects the lease, it must return possession of the property to the landlord. Unlike the landlord to an assumed lease who is made whole upon assumption, the landlord to a rejected lease retains only: (a) an unsecured claim for unpaid pre-petition rent or other amounts; (b) an administrative (dollar-for-dollar) claim for unpaid post-petition rent; and (c) a rejection damages claim (unsecured) for future rent that would have been due but for the rejection. While the landlord is entitled to rejection damages, such damages are capped. Rejection damages are capped at the greater of one (1) year of rent or the rent for fifteen percent (15%), not to exceed three (3) years, of the remaining term of the lease. Rejection damages may be cut-off entirely if the landlord is able to re-lease the space for rent that will cover the claim.
Regardless of whether the tenant assumes or rejects the lease, tenants must pay post-petition rent. The bankruptcy code requires a tenant to comply with its obligations under a lease during the pendency of the case. If the tenant fails to comply with the lease terms, the landlord may have grounds for relief from the automatic stay to pursue eviction. Whether cause exists to grant relief from the automatic stay will depend on the particular circumstances of each case. For example, if the post-petition rent is not being paid, if insurance coverage does not remain in force or the property is in danger, a bankruptcy court may find cause for relief from the stay. On the other hand, if the tenant cannot continue its business without operating in the leased premises, a court may consider the property necessary for the tenant’s reorganization and be less likely to grant relief from the automatic stay. Experienced bankruptcy counsel can help assess the merits of any stay relief motion and should be consulted if the tenant fails to uphold any of its post-petition obligations under the lease.
PRE-BANKRUPTCY PLANNING: Hedging your risks when a commercial tenant files for bankruptcy
Landlords can hedge risks when a tenant files for bankruptcy by obtaining additional security to secure the lease,
which will maximize potential recovery in the event of a tenant bankruptcy.
Consider requiring a significant security deposit, including in the form of a letter of credit. Security deposits make a landlord a secured creditor to the extent of the deposit. In some cases, landlords can offset rent payments with a security deposit, which can enhance recovery to the landlord if the tenant ultimately rejects the lease.
Obtaining a third-party guaranty (from an individual or affiliate entity) of the tenant’s obligations under the lease affords a landlord with non-bankruptcy collection opportunities. In most cases, guarantors, unlike debtors, can be pursued for the full amount of the debt owing without respect to the cap on rejection damages that applies to a debtor.
In short, strong lease drafting coupled with vigilant enforcement of the landlord’s rights in and out of the bankruptcy court can make a significant difference in timely maximizing recovery from a defaulted tenant. 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.
For More Information on what to do when a commercial tenant files for bankruptcy:
Julie M. Murphy, Esquire
Hyland Levin LLP
6000 Sagemore Drive, Suite 6301
Marlton, NJ 08053-3900