Executory Contracts Under the Proposed Legislation

The proposed amendment to §365 of the Bankruptcy Code (governing the assumption or

rejection of leases and executory contracts) brings some interesting issues to the surface. We

should consider whether these changes are practical and make sense. Surprisingly, there has not

been more focus on the proposal, given the ramifications resulting from the change.

</p><p>Under current law, debtors/trustees have 60 days from the filing date to assume or reject

leases subject to extension, which may be granted at the discretion of the court. H.R. 833, as

initially introduced in this session of Congress, sought to limit the time period to 120 days and

take away from the court any discretionary powers to extend the limit.

</p><p>The bill passed the House in modified form: The time limit is 240 days from the date of filing

without any possibility of extension, except upon the motion of the landlord. This change has

serious implications in retail cases. When a lease is assumed today, the debtor must pay the

landlord all unpaid back rent and charges, including pre-petition amounts. Moreover, under

current law, once a lease is assumed, if it is later rejected the entire landlord claim (the rental

stream over the life of the lease—unlimited by §502(b)(6) in this case) becomes an

administrative priority claim, entitling the landlord to payment before general unsecured

creditors. The House Judiciary Committee modified the amount of this administrative claim to

one year. However, the landlord retains the right to file for additional rejection damages

(unlimited §502(b)(6) limitations) which would be treated as general unsecured claims.

</p><p>Debtor and creditor lobbies have made several arguments to Congress. Secured creditors

sometimes consider leases "boot collateral" that help mitigate risk in debtor-in-possession

(DIP) financing. Further, they expect debtors to adhere to business, not bankruptcy, law when

making decisions that will be in the best interest of the overall health of the business. They have

little to no interest in the sale of their collateral being used to pay pre-petition claims.

Unsecured creditors face difficult issues as well. They are compelled to force decisions due to

time frames, which may affect the value of their equity in claims and proposed distributions.

Further, with the alarming increases in administrative insolvency in retail cases, which affects

trade vendors (one of the critical components of any reorganization), they would ask all to

consider if the possible additional burden put on the administrative class is practical. This

burden pushes down the unsecured class. Finally, the debtor and its issues must be taken into

account. Consider the retailer who files for bankruptcy in January. By the end of August, it

must decide whether to assume or reject before the Christmas season, which is essential to the

retailer's profitability. How does the retailer fix the problem and make the significant and

material assumption or rejection decisions without going through Christmas? That's just not

practical. The debtor believes it will have to make these decisions blindly without enough

consideration for the reorganization process.

</p><h3>A Landlord's View</h3>

<p>A memo issued by the International Council of Shopping Centers titled "Bankruptcy Talking

Points" highlights some issues that should be considered; my views on each point are italicized

below.

</p><ul>

<li>Unfortunately, a growing number of businesses are using the bankruptcy system as a

business device to reorganize and get rid of unprofitable leases at the expense of shopping

center owners.

</li></ul>

<p><i>A reorganized business should be a better business. Bankruptcy is a concept of equity

considering the interests of all creditors.</i>

</p><ul>

<li>Unlike banks and vendors that can decide whether or not to continue lending money or

supplying goods and services to a retailer that has filed for bankruptcy, shopping center

owners are compelled creditors. These property owners must continue to lease their space to

bankrupt tenants, regardless of their ability to make regular rental payments.

</li></ul>

<p><i>Other creditors face long-term contract issues. Further, courts have demonstrated a heightened

sensitivity to the payment of post-petition rent.</i>

</p><ul>

<li>Although current law provides that tenants are required to assume or reject their leases

within 60 days after filing for bankruptcy, bankruptcy court judges have routinely granted

exceptions and extended this time period for months, even years. In most cases, the

exception to the 60-day rule has taken over the rule itself.

</li></ul>

<p><i>Maybe 60 days is not practical. If we cannot have faith in the wisdom and discretion of the court

considering all the cases, not making a point on the exceptions, then we are simply left with no

organized process at all. It gets back to the premise of equity vs. black-and-white law.</i>

</p><ul>

<li>The longer a bankruptcy case drags on, the fewer funds there are available to make lease

payments.

</li></ul>

<p><i>I think the courts have demonstrated that they view the payment of post-petition differently

than this point may suggest.</i>

</p><ul>

<li>There needs to be a fixed period of time (120 days is preferable, 180 days is acceptable) for

bankrupt tenants to decide whether to assume or reject their leases. Extensions could be

granted if agreed to by the property owner. This would create certainty to a process that has

all too often gone on indefinitely.

</li></ul>

<p><i>The courts must consider all creditors in the reorganization process, not just the singular

creditor landlord and his singular space. There have been times when things probably have gone

on too long. They are the exception, not the rule. Consider the whole, not the exceptions.</i>

</p><ul>

<li>Retailers usually know months before filing for bankruptcy which stores are profitable and

which are not. Therefore, a business should certainly know within 120-180 days after

filing which leases need to be assumed and which ones need to be rejected.

</li></ul>

<p><i>Landlords are giving the retailers way too much credit as to what they really know.</i>

</p><ul>

<li>Although tenants in bankruptcy are still required to pay rent, many are unable to do so for

obvious reasons. Owners are not given an expedited judicial or administrative process in

which to collect back rent.

</li></ul>

<p><i>Maybe the process could use improvement, short of a fixed time limit. Also, it's unclear to me

what the "obvious reasons" are.</i>

</p><ul>

<li>Even when bankrupt tenants do pay their rent, they often close their stores, creating an

overall depressed environment for the rest of the shopping center. In addition, often the

rent of the bankrupt tenant, as well as the other stores in the center, may be based upon a

percentage of each store's sales. Therefore, when one store goes dark (especially a large

anchor), not only are its rental obligations reduced, but so are its neighboring stores'

obligations. This situation can be disastrous for the shopping center owner, the neighboring

stores, their employees and the community as a whole.

</li></ul>

<p><i>This is a good point that should be considered by the court in the decision to grant an extension of time to accept or reject.</i>

</p><ul>

<li>Shopping center owners are often excluded from participating on the creditors' committees

of their bankrupt tenants, even though they have a large stake in the outcome of the

proceedings. The law should give owners greater access to these committees in order to

ensure adequate representation of their interests.

</li></ul>

<p><i>Sounds like landlords have issues that the U.S Trustee's Office should consider more carefully.

Maybe dialog and education in these areas is more practical and will ensure better results than

changing the law.</i>

</p><h3>Conclusion</h3>

<p>Landlords and their debtor-tenants each have some points to make in this pending legislative

dispute. A careful balancing of the equities is essential. How the issue is resolved by Congress

this fall could have a major impact on retail reorganizations.