Retailers Using Chapter 11 To Break Lease Agreements

Companies that have filed for Chapter 11 bankruptcy are using the court protection to end long-term lease agreements early and close thousands of stores, reported Bloomberg.

The news site named Neiman Marcus Group Inc, Brooks Brothers Group Inc, J.C. Penney Co., J. Crew Group Inc. and the owner of Ann Taylor as companies looking to use this protection to avoid lease renegotiations and even back out of rent obligations altogether.

But the ripple effects are daunting, as the moves could threaten the half-trillion-dollar market for commercial mortgage-backed securities.

“This is now black-letter law — a debtor can cram down a landlord,” Melanie Cyganowski, a partner at law firm Otterbourg PC, told Bloomberg. “If this becomes a tsunami of retailers rejecting their leases, it’s going to trigger another part of the sea change — the mortgages held by the landlords.”

As Bloomberg noted, bankruptcy gives tenants the power to reject leases and get out of payments, but the result is a mass of landlords missing their own mortgage payments.

Toronto-based investment group Brookfield has been forced to skip mortgage payments as stores in its malls miss rent payments, PYMNTS previously reported. Seventy-five percent of its tenants have requested changes to their leases, according to the asset manager.

Retailers can also rework lease negotiations with terms like rent abatements without declaring bankruptcy, but the out-of-court negotiations can be challenging and expensive, Navin Nagrani, an executive vice president at Hilco Real Estate, told Bloomberg.

“Sometimes bankruptcy is the most advantageous way to get out of those leases,” he said, noting that some large retailers answer to hundreds of different landlords.

Chapter 11 filings are up 43 percent from last year; almost 3,600 businesses had declared bankruptcy by June. The Small Business Reorganization Act that passed in February has made it easier for companies to do so without forcing them into liquidity to pay off creditors. The new law gives small businesses more leverage in negotiating with landlords and suppliers.

Some of the retailers filing for Chapter 11, such as J.C. Penney, were in trouble before the pandemic, and are using this time advantageously.

“Every fashion retailer really should be examining the benefits of reorganization. With COVID-19, there is a window of opportunity right now,” noted Anthony Lupo, a partner at law firm Arent Fox, in a Forbes report. “That window is closing soon, so if you don’t restructure now when people are more than willing to renegotiate, you’re going to be forced to go to them later.”