New Consumer Bankruptcy Law Has a Surprise in Stor
Great Neck, NY, April 20--On April 14, the House of Representatives passed S.256, known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, sending the bill to President Bush, who is expected to sign this week.
This law was heavily promoted by the retail industry in order to improve the legal rights of retailers against defaulting consumers.
What the retail industry may not have realized is that their landlords were also heavily promoting this legislation - although a different provision. The landlords succeeded in amending the existing Bankruptcy Code in order to severely restrict the flexibility of retailers who enter bankruptcy and to shift value away from the retailer towards its landlords.
In particular, the law imposes a rigid seven month deadline on the retail-debtor to decide which leases to keep and which leases to jettison. As a result, retailers who are facing bankruptcy will now want to seek the counsel of a real estate expert as soon as possible.
The Bankruptcy Code has provided and continues to provide tenants with a very powerful right: the right to "reject" a lease.(1) "Rejection" is the statutory right to breach a lease. Retailers use this power to exit under-performing or overly expensive leases or to close their stores as part of a liquidation.
When a lease is rejected, the landlord receives a damage claim against the debtor, which is paid at the end of the bankruptcy proceeding in bankruptcy dollars (i.e., cents on the dollar). For the benefit of other creditors - to prevent their claims from being diluted by landlords' damages claims- the Bankruptcy Code caps the landlord's rejection claim at three years rent.(2)
The Bankruptcy Code specifically grants tenants 60 days to "assume or reject" a lease, with the opportunity to extend that deadline.(3) Bankruptcy Courts routinely extend the 60 day deadline in order to give the retail-debtor time to evaluate its business, business plan, store performance and even to evaluate its sales through a Christmas season.
"I have worked with hundreds of retailers and have seen how important it is for a retailer in bankruptcy to have time to evaluate store performance before electing to assume or reject a lease. This new law really puts retailers under the gun. Seven months sounds like a long time but it's not, especially if it doesn't include the Christmas selling season," says Harold Bordwin, president and CEO of Keen Realty, LLC. Bordwin was previously called upon by Congress to testify about the impact of this provision.
Bordwin also sees other implications from this new law. "There are at least two far reaching implications of forcing retailers to make the assumption/rejection decision within seven months.
"First, upon assumption of a lease the tenant is required to 'cure' all defaults. Curing defaults means paying the landlord, in full, for any unpaid back rent and other charges. Why should landlords be paid these claims in full while all other unsecured creditors have to wait until the end of the proceeding to be paid, at which time they will be in 'bankruptcy dollars' (i.e., cents on the dollar). Paying the landlords' cure claims in full only seven months into a bankruptcy is not only unfair to other creditors but it may also create a liquidity crisis and undermine the viability of the retailer's business.
"Second, in the event that the tenant-debtor later rejects an assumed lease, the landlord's position as a creditor is significantly enhanced, to the detriment of other creditors. The lessor will have an administrative expense claim (which is a higher priority claim than the claim of other general unsecured creditors) for two years rent. That claim gets paid in full before other creditors get paid in bankruptcy dollars. The lessor's remaining damage claim will be treated as a general unsecured claim and capped at three years rent."
