Pharmacy giant Rite-Aid’s bankruptcy and proposed reorganization plans have had wide-ranging and cascading impacts from coast to coast. But perhaps the most immediate and acute effects of the company’s insolvency are felt by the commercial landlords that host the scores of leased locations that Rite-Aid intends to close as part of its restructuring strategy. This includes its planned sale of 78 Rite Aid and Bartell Drugs neighborhood pharmacy leases in free-standing buildings and retail shopping centers across nine states.
The challenges and uncertainty now faced by Rite-Aid’s lessors illustrate those regularly confronted by commercial landlords when a tenant’s bankruptcy or insolvency leaves them with unoccupied spaces and significantly diminished cash flow. As such, landlords must understand their options, rights, and remedies under the Bankruptcy Code to minimize the fallout and avoid inadvertent and costly mistakes when a tenant suddenly shutters its doors during a current lease term.
Assumption, Rejection, and Assignment of Lease Under Bankruptcy Code Section 365
Bankruptcy Code Section 365 governs the treatment of commercial leases in bankruptcy cases. Since the automatic stay, at least initially, limits the remedies and actions a landlord can take regarding the defaulting tenant, what happens next is largely up to the tenant.
A tenant typically has 120 days after filing its bankruptcy petition to either reject, assume, or assume and assign or sell the lease.
While a bankruptcy judge can extend the 120-day deadline for an additional 90 days for good cause without the lessor’s consent, the landlord’s assent is required for any further extension requests.
During this period, the tenant must continue to satisfy its ongoing lease obligations, including paying rent, with post-petition rent obligations prioritized as an administrative claim. Notably, the lessor must continue to comply with the lease’s terms during this time or risk running afoul of the automatic stay.
If the debtor does not assume or reject its lease within the applicable time, the court will consider the lease rejected, and the tenant must then immediately vacate the leased premises.
Option 1: Rejecting the Lease
If a debtor elects to reject the lease, it essentially defaults and, accordingly, must vacate the premises. Upon rejection, the lessor can assert a “rejection damage” claim, which is considered a prepetition unsecured claim—sharing pro rata with other general unsecured creditors. Unlike other rejection damage claims, however, Bankruptcy Code Section 502(b)(6) caps the lessor’s rejection claims to the greater of one year’s rent or 15% of the rent of the remaining term of the lease, capped at no more than three years of total rent.
Option 2: Assuming the Lease
If the lessee opts to assume the lease, it essentially agrees to continue the lease, comply with its terms going forward, and cure any defaults. The lessee will identify the defaults to be cured and afford the lessor the opportunity to object to the proposed cure if it is insufficient. The debtor must also compensate the lessor for “any actual pecuniary loss” caused by the debtor’s default and provide the lessor with “adequate assurance of future performance.”
Option 3: Assuming and Assigning (or Selling) the Lease
Notwithstanding any anti-assignment language in the lease or any landlord objections, the debtor can elect to assume the lease and assign or sell it to a third party, as Rite Aid seeks to do with several leases. As with all lease assumptions, the tenant (and its assignee) must cure any outstanding defaults and provide adequate assurances of the assignee’s future performance of its lease obligations.
Additional Protections and Assurances for Shopping Center Lessors
Many, if not most, of the leases Rite-Aid seeks to unload are in retail shopping centers. The Bankruptcy Code provides special protections for shopping center lessors when a debtor assumes and assigns its lease.
Specifically, Section 365(b) requires debtors and assignees to provide the landlord with “adequate assurance” that:
- The source of rent and other consideration due under the lease and the financial condition and operating performance of the proposed assignee and its guarantors, if any, will be similar to the financial condition and operating performance of the debtor and its guarantors, if any, as of the time the debtor started its tenancy.
- Any percentage of rent due under the lease will not decline substantially.
- Assumption or assignment of such lease is subject to all lease provisions, including those relating to radius, location, use, or exclusivity, and the assignment will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to the shopping center.
- Assumption or assignment of the lease will not disrupt any tenant mix or balance in such shopping center.
Failure to deliver any such assurances can support a lessor’s objection to any proposed assumption or assignment of the lease.
If you have concerns about your options as a landlord regarding an insolvent or bankrupt tenant or need assistance protecting your rights in a pending bankruptcy proceeding, please contact Anthony D’Artiglio at Ansell.Law.