The Pain of Retail Bankruptcies Extends to Landlords and Remaining Tenants

This year is shaping up to be an especially tough one for retailers across the country.

The current environment has resulted in many national and regional retailers closing up shop and turning to bankruptcy as a means of downsizing or liquidating. Whether the retailer has too many stores, an obsolete business model or declining sales due to the rise of e-commerce, bankruptcy might seem like the only way out.

According to the Bureau of Labor Statistics and International Council of Shopping Centers, nine chains have filed for Chapter 11 bankruptcy protection this year and nearly 90,000 retail workers have lost their jobs since last October. Bankruptcies such as HHGregg and Rue21, along with negative media reports from big names, like J.C. Penney and Sears, have left many wondering how they're affected by a retailer bankruptcy.

And it’s not just landlords who need to know; fellow retailers are also impacted.

While filing for bankruptcy might be a means of survival for many retailers today, the results can be quite challenging for landlords and might also cause circumstances that are unfavorable for other tenants in the shopping center.

For landlords, profit loss is a major concern. Shopping center owners being hit with one or multiple tenant filings, which end in liquidation more often than successful reorganization, may struggle to find a replacement tenant. If it's a big-box space, the list of potential users is limited, making the search for a replacement tenant more difficult.

Losing a large tenant means losing a large sum of rent, too. In addition to losing money from a vacancy, a co-tenancy clause in the retail lease may allow other tenants to get a reduction in rent from the landlord if certain tenants leave the property. Therefore, a single bankruptcy could result in the landlord losing a large sum of money from multiple tenants.

Landlords also face property management issues. When retailers go out of business, they often promote “going out of business” sales. Large, garish signs and heavy promotion of these sales can degrade a shopping center’s perceived status, which adds to the difficulty of finding a replacement tenant and may upset existing retail tenants. When the sales end and the space is turned over to property management, retailers in bankruptcy often leave items like hangers and shelves behind. Removing these items and preparing the space for a new tenant is both time consuming and costly for landlords.

Finally, in Chapter 11 reorganization, debtors have the option of assigning an assumed lease to a third party. This is often done through an auction in which a lease is sold. While there are legal protections for landlords in this type of situation, a landlord is generally prevented from vetoing the debtor’s choice of tenant under the bankruptcy code. Thus, a landlord may have very little control over the assignee, which can be frustrating for landlords. A co-tenant that isn't protected with an exclusive use provision may be unhappy with an assignee that competes with them.

Sadly, we will continue to see more store closings as e-commerce transforms the face of retail. That’s why it's crucial for both landlords and tenants to understand how retailer bankruptcies might affect them.

Sam Arden is a partner with national commercial real estate firm Hartman Simons & Wood, LLP.