Daily Development for Wednesday, April 21, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

BANKRUPTCY; LEASES; ASSUMPTION AND REJECTION;
ASSIGNMENT; RESTRICTIONS ON ASSIGNMENT; SHOPPING
CENTERS: Shopping Center landlord may not enforce use clause
restricting use to identified retail outlet and must demonstrate scheme of
integration of tenant uses into a viable "tenant mix" through its leasing
policies in order to argue that a change of use upon assignment is
protected by "tenant mix" considerations under Bankruptcy Code Section
365(b)(3).

LaSalle National Trust v. Trak Auto Corp., 288 B.R. 114, 2003 U.S.
Dist. LEXIS 6029 (1/10/03)

Bankrupt tenant was withdrawing from all its auto parts stores in a four
state region.  This included the store at tenant's retail center, which
consisted of twenty five "commercial locations," nearly all of which were
retail stores.  Tenant proposed to affirm the lease and assign it to a new
tenant who would operate a discount clothing operation.

Landlord objected on the grounds that the new tenant's use was
inconsistent with the use clause, which required that the store be operated
as a "Trak Auto Store," and in addition interfered with the tenant mix.
Landlord's expert testified that the percentage of clothing stores in
Landlord's center already exceeded an optimal mix, and that committing
the large floor space of this store to clothing would be very harmful to
the viability of the center.  Landlord's expert testified that the national
average for clothing stores in retail centers was 10%, while the
percentage following the assignment in this case in Landlord's center
would increase to 20.8%.

Landlord's center was more like a "downtown shopping district" in that
there were nine other stores located in building contiguous to Landlords
stores that were virtually indistinguishable to customers from the stores
operated by Landlord.  Further, there were 28 more stores directly across
the street from Landlord's properties.  Landlord had no control, of course
over operations in any of these properties.   The Bankruptcy court had
found that the interests of "tenant mix" raised by Landlord were relevant
only if landlord operated a "shopping center" entitled to special
protection against assignment as set forth in 365(b)(3) of the Bankruptcy
Code, and Landlord's properties did not satisfy the test for a "shopping
center."

The court here affirms the ruling of the Bankruptcy Court on the
following points:

1.  The use clause was an effective restraint on alienation of the lease and
could be avoided in bankruptcy.

2.  The special provisions of Section 365(b)(3) dealing with preservation
of landlord's interest in synergy in a shopping center may have been
applicable here even though landlord's space was not a true center.  The
trial court should have taken more evidence on the point.

3.  Nevertheless, even if this was a true center, landlord's arguments
concerning the negative impact of the increase in retail clothing space
were unfounded.

In determining that the use restriction operated as a de facto restriction
on assignment, the court relied heavily on In re Rickels Home Centers,
Incl, 240 B.R. 826 (Bkrtcy. D. Del. 1998).  (The DIRT DD for 8/11/98)
In Rickels, the Delaware court held that restrictions on the purpose and
size of the store operations in a shopping center were de facto restrictions
on assignment and invalid under the Bankruptcy Code.

With respect to the specific provisions of the use clause, the court had
little problem with interpreting the clause, in context as a de facto
restraint on leasing.  Although the Bankruptcy court had  noted that the
area was saturated with auto stores and no prospective assignee would
even bid on the store as limited to that purpose, the court on appeal
elected not to rely upon that analysis.  Instead, it noted that the use
limitation was not only to auto parts stores, but to an auto store
denominated "Trak Auto, " and that this restrictions in effect prohibited
leasing to anyone but the original bankrupt tenant.  Clearly in the view of
the court, this was a de facto prohibition on leasing inconsistent with the
policies of the Bankruptcy Code.

Landlord relied upon a more recent Delaware Bankruptcy case, Sun TV &
Appliances, Inc., 234 B.R. 370 (Bkrtcy. D. Del. 1999), for the
proposition that a restriction on use would be upheld even when there
was an impact on assignability.  The court here cited to the Sun TV case a
number of times, but barely discussed it at all.  Indeed, it is a strong case
for recognition of the need for preservation of tenant mix.  It makes the
point explicitly that the value to the estate of assignment to a non-
conforming assignee ought not to matter at all if there is danger to the
viability of the center.

Indeed, the specific language of 365(b)(3) seems to require rigid
adherence both to the requirements of a use clause and to recognition of
tenant mix:

     (3) For the purposes of paragraph (1) of this subsection and
     paragraph (2)(B) of subsection (f), adequate assurance of future
     performance of a lease of real property in a shopping center
     includes adequate assurance--
     (A) of the source of rent and other consideration due under such
     lease, and in the case of an assignment, that the financial
     condition and operating performance of the proposed assignee
     and its guarantors, if any, shall be similar to the financial
     condition and operating performance of the debtor and its
     guarantors, if any, as of the time the debtor became the lessee
     under the lease; (B) that any percentage rent due under such lease
     will not decline substantially; (C) that assumption or assignment
     of such lease is subject to all the provisions thereof, including
     (but not limited to) provisions such as a radius, location, use, or
     exclusivity provision, and will not breach any such provision
     contained in any other lease, financing agreement, or master
     agreement relating to such shopping center; and  that assumption
     or assignment of such lease will not disrupt any tenant mix or
     balance in such shopping center.

The court here noted that other courts have construed this statute to
require that there actually be a designed tenant mix that deserves
protection.  The simple presence of a shopping center is not enough if
there is no evidence of an operating scheme to achieve tenant mix.  It is
true that the Sun TV case did emphasize the special integrated nature of
the stores in that complex (which also was not a classic "mall-type"
center.  Although the lease in question was not a percentage lease, many
other stores in the center were, and stores were expected to draw
customers not only to their own location but to others.

In the instant case, however, the court noted, first, that landlord had very
little control over tenant mix because there were so many other stores
nearby and that, second, most of the arguable objectives that could be
achieved by restricting the instant store to an auto parts outlet were not
proven.  Other stores in the center already sold auto parts, and there were
other tenants that drew male shoppers that were the primary anticipated
customers of an auto part store.  The court also noted that many of the
other leases in the center did not restrict the amount of space that could
be devoted to the sale of clothing, thus belying the landlord's claim that
there was a scheme that relied upon a limitation on the amount of space
devoted to such a purpose. In short, the landlord did not demonstrate that
"the alleged tenant mix was part of the bargained-for-exchange of its
leases and the leases of the other tenants."

Comment 1: The editor, and many commentators, viewed the Rickels
case as a disastrous mistake.  Its interpretation of space restrictions as
inconsistent with assignments basically gutted the essence of 365's
special protections for shopping centers.  On appeal, the holding in
Rickels was not exactly affirmed and not exactly reversed.  Instead, the
appeals court got caught up in procedural detail that operates to the
disadvantage of the landlord's making a case, but did not expressly find
that 365(b)(3)  could be so summarily ignored.   Indeed, the subsequent
holding in Sun TV, coming from the same judicial district, was a distinct
ray of hope on the Rickels issue.

This case does not go nearly as far as Rickels, although it is disconcerting
that it cites it with such approval.  Certainly a use restriction that says, in
effect, there can be no assignment to anyone who does not use the
original tenant's name is very, very restrictive.  Although the statute says
expressly that use provisions are to be protected, regardless, if there's a
shopping center, one can imagine a court concluding that the overall
purpose of permitting tenants to assign leases except when shopping
center's business synergy is endangered would be best served by
bypassing such a provision.

The bottom line, then, is that landlords ought not to view tenant-specific
use clauses as likely to do them much good in a tenant bankruptcy.

Comment 2: Again, the court's conclusion that there really was no
"tenant mix" consideration to be taken into account here, since the
landlord had not made an adequate showing that it had developed a
tenant mix concept, also provides a good practice lesson.  To the extent
possible, tenant mix considerations should be made explicit.

Of course, competitive factors and available tenants will compel some
variation on tenant mix from time to time, but there could still be a kind
of "master business plan" that contemplates alterations and variations,
and a history could be kept of when and how these alterations and
variations came about.  As the court focusses upon whether tenant mix is
a part of the overall leasing bargain for the landlord and each tenant, this
master plan backdrop could be a very useful document.  Is it practical?
Who knows.  The editor is in the suggestion business, not the retail
business!
Also see:  In re Paul Harris, 1992 Bankr. LEXIS 2418(U.S. Bktcy Ct.,
S.D. Ind.) (assignment of a women's apparel store to a maternity store,
despite lease requiring that tenant operate under same name and for same
purpose; ct. held that such provision was "antiassignment"clause and
invalid).

Readers are encouraged to respond to or criticize this posting.

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