The Plight of a Commercial Landlord in the Current Covid-19 Environment

A number of  serious economic downturns in recent times have impacted the leasing of commercial real estate.  There was the 1973 oil crisis coupled with the stock market crash which followed.  Who can forget the high mortgage interest rates of the period from 1979 to 1986?  Real estate was not doing well in 1990.  Many real estate lawyers at that time became work-out and bankruptcy lawyers, as their clients were falling off a cliff.  Then came the terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001, and the ensuing economic calamity.

The worst was yet to come.  The economic meltdown which began in 2008 led to a near-collapse of our banking system as we know it.  The bailouts which followed helped prop up a teetering economy, but recovery was slow.  Without serious government intervention, we probably would have gone into a depression at the time.  The problems associated with the wave of foreclosures and bankruptcies emanating out of that period still linger today.

Over the course of recent times,  grocery stores became larger and larger.  You would go to the food market to buy not only food, but prescription drugs and items associated with general stores, drug stores or office supply stores.  Other “category killer” businesses grew to take over lines of business, including hardware, clothing, electronics, and others.  Commercial landlords leased entire outdoor shopping centers to big box stores expecting tremendous foot traffic.

Then came the advent of buying goods and services online and Amazon was born.  The big box stores were no longer sustainable without substantial foot traffic.  Many of the big box stores and malls, already dying before the Covid-19 pandemic, were struck with a vengeance in March of this year.  Even prior to the Covid-19 pandemic, analysts were predicting that this would likely  be a year of major national retail chain failures.

Complicating the big picture was the aggressive use of highly-leveraged debt to acquire major businesses.  Many large retail businesses are owned by hedge funds and are highly undercapitalized, without enough value to recapitalize in a prudent manner.  To the point, no bank or lending institution wants to go near these once retail giants.

Balanced against the excessive use of debt financing, interest rates have been at record lows for the past several years through quantitative easing by the Federal Reserve.  Up until recently the stock market had gone up and up.  Accordingly, despite certain market forces moving the economy downward, there had been enough good things happening to keep the ship afloat.  Low interest rates have been a blessing to many businesses of all sizes and have probably been key in propping up the stock market.

Enter Covid-19.  Everything or almost everything has stopped.  Traditional retail is currently being crushed.  Office buildings are going to have trouble as more and more tenants cannot pay their rent.  The entire way commerce is conducted is going to go through revolutionary changes.  This is not a temporary situation which will magically disappear in a few months.  Shifts in consumer spending and socializing are being normalized to the point that people may not even want to go back to business as usual.

The passing of the CARES Act and the floating of friendly Payroll Protection Program (“PPP”) loans on an unsecured basis to many businesses will help in the short run, although it appears that the program has been “too little-too late” for many small retail businesses, particularly businesses with less than fifty employees.  The biggest winners under the PPP program have been “essential businesses” with high payroll costs which have been able to operate during the government-imposed shutdowns.

The lack of cashflow caused by the government-directed shutdowns is going to force a record number of retail and business failures, leaving landlords with a lot of empty space and forced to participate in many bankruptcy proceedings.

This is not a time for a commercial landlord to panic.  It is time for a commercial landlord to be smart and engaged.  If a landlord receives a notice of a bankruptcy filing of an existing tenant, quick decisions need to be made as to how to approach the matter.  Having good legal advice at the earliest stage of a major chapter 11 case is critical because events occur in the beginning which set the stage for what happens later.  The Bankruptcy Code has provisions which are beneficial to landlords, but they are not self-enforcing.  Debtors and Trustees, given the opportunity, may try to delay the payment of post-petition rent.  Debtor-In-Possession Orders and Cash Collateral Orders must be scrutinized to make sure that the landlord is not being disadvantaged by other creditors who want to push to the front of the line.

Commercial landlords must realize that the decision to assume a lease or to reject a lease is a decision which is made by the Debtor—not the landlord.  Although there are time constraints and other constraints on a debtor’s exercise of its rights to assume or reject a lease, the Bankruptcy Courts are generally going to approve the Debtor’s decision to assume or reject.  Since assumption means that the landlord may be paid in full, anything the landlord can do to point the debtor in that direction is helpful.  There is a time to litigate hard and a time to negotiate and be flexible.  It is a chess game and a game of chicken being played at the same time.  Each side is free to play the game within the rules of the Court and the Bankruptcy Code.

Sometimes a landlord has to come to the realization that it is going to get nothing out of the case and simply needs to move quickly to obtain relief from the automatic stay to regain possession of the premises and terminate the lease.  Even that situation is not without turbulence.  There may be multiple secured creditors who have left behind their secured collateral at the premises.  Employees may have left behind their personal effects.

Even in a case with bad facts, it may be that the landlord should be able to obtain some post-petition rent and have it paid as an administrative expense on the same playing field as the debtor’s professionals.    Since most skilled professionals who do major bankruptcy work like to be paid in full, they will work hard to make sure that the estate is not administratively insolvent so that all administrative claimants, including the landlord, are paid in full before the unsecured creditors are paid anything.

There is a complicated, almost incomprehensible formula, for computing the amount of a pre-petition rejection damage claim of a landlord.  The issue presented is whether a landlord should even bother filing the claim.  If there is no money in the case beyond the administrative claims, filing the claim is a waste of time and money.  The problem is that it is not clear at the outset of a case whether there will be any money.  The Debtor or Unsecured Creditor’s Committee may find ways to pay unsecured creditors by selling valuable assets above the value of the security interests of the secured creditors and by pursuing so-called bankruptcy avoidance actions which may not be subject to the security interest of the secured creditors at all.  Every bankruptcy lawyer has a story about a case which seemed to be a “no-asset” case at the outset which turned into a significant asset case by the end.   A landlord will always smile when receiving a check on account of a pre-petition rejection claim years after the case was initially filed.

The attorneys at Earp Cohn stand ready to assist landlords in protecting their legal rights and financial interests during the current economic uncertainty.  Please contact us if we may assist you.