Daily Development for Wednesday, August 11, 1999

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

Thanks to DIRTer Harris Ominsky for providing the summary upon which this DD was based.

BANKRUPTCY; LEASES; ASSUMPTION OR REJECTION; SHOPPING CENTERS: Unreported Delaware case holds that restrictions on use that amount to a restraint of assignment are inconsistent with "free assignment" provisions of Section 363(b)(3) and therefore not protected by the special "shopping center preservation" provisions of Section 365(b)(3).

In re: Rickels Homes Centers, Inc., Case No. 9216 (U.S.D.C. Del. 3/6/98

Rickels operated a large chain of home improvement stores located primarily in shopping centers. Typically, the stores were reasonably large 24,000 square feet but were not the principle anchors in their locations. When Rickels went bankrupt, the trustee negotiated to sell 24 of the leases for Rickels stores to Staples, which intended to use the sites for office supply stores. Staples marketing concept did not involve use of stores of the same size as Rickels, and consequently Staples anticipated dividing up the stores into smaller pieces and subletting portions of the premises to other retailers.

Three shopping center landlords filed suit to restrain the transfer of the Rickels stores in their locations to Staples, arguing that the transfers would violate various restrictive provisions in their leases, including use requirements, prohibitions on subdividing the space and remodeling, repainting without the landlord's consent, and that the assignments would lead to a shut down of the space for as long as six months, causing an interruption in percentage rent.

The Bankruptcy Code has been amended to provide special protection for shopping center lenders in Section 365(b)(3, which provides that a bankruptcy trustee can assume, and assign a defaulted lease only when it can provide "adequate assurance of future performance" of the lease provisions, including: (A) that the source of rent and other consideration due (the assignee and guarnators) shall be similar in terms of financial condition to the dbetor and its guarnators at the time the debtor became a lessee:

(B) that any percentage rent due under the lease will not decline substantially;

( C) that the assignment is subject to all the lease provisions, including readius, ocation, use or exclusivity provisions, and that the assignee will not breach either these provisions whether contained in the lease, a financing agreement or the master agreement relating to the center; and

(D) that the assignment will not disrupt any tenant mix or balance in the shopping center.

The Bankruptcy Court rejected most of the landlord's objections, concluding that they amounted to total restrictions on assignment as applied in this case, and therefore were prohbited by the "free assignment" bankruptcy law provision, Section 363(b)(3). The court acknowledged Section 365(b)(3), but concluded that the landlords' reliance on these provisions was either unfounded or "disingenuous." (In at least one store, the landlord could have relet the space for $10/sq. ft. while the lease paid it $2.22/sq.ft.)

The court stated that there was effectively no market for large "home center" stores any longer, and that to restrict the premises either to the same size or purpose set forth in the original lease would lead to a prohibition on assignment. The would have virtually no purpose; and this certainly was not a protection to which the landlord was entitled. The court also noted that Staples would not unduly interfere with tenant mix in any of the objecting center. It pointed out that at least one of the objecting landlords had a number of Staples stores at other centers it owned, so it was unlikely that its overall marketing scheme was inconsistent with the presence of a Staples. As to the closure for six months, the court pointed out that the bankrupt tenant had not been paying percentage rent for some time, and that consquently the landlord's percentage rent flow would not be adversely affected.

The court did hold that the minimum achievement of gross sales requirements in the lease could be enforced against Staples and that it would not permit assignment if indeed other center tenants had exclusive use clauses that Staples would violate. Finally, it concluded that the partitioning of the stores was a "one time" permission, and that the general prohibition against partition would apply to any proposed repartition in the future.

The Third Circuit has denied review of the case.

For a similar holding, see In re Paul Harris, 1992 Bankr. LERXIS 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).

Comment 1: The editor does not have the official report of the case, and it is not clear from his report what the court did about application of the percentage rent clause to the sublessees. As they were sublessees, one would assume that their sublease rent would be included in Staples gross revenues, but that the percentage rent clause in the master lease would not be applied directly to them. If this is the case, then of course, the landlord indeed may experience a decline in total percentage rent from the space as compared to what would have happened if the existing clause were appliced to all occupants.

Comment 2: Noted Pennsylvania real estate commentator Harris Ominsky presented this case recently at an American Bar Association meeting and indicated that in his view it represents an extension of the bankruptcy court's powers into the landlord's contract rights, and that some of the protection anticipated from the enactment of Section 363(b)(3) is not being realized.. He further pointed out that some commentators have suggested that landlords attempt to protect themselves by included clauses that "capture" all or a percentage of any premiums obtained from the tenant by assigning or subletting. But Ominsky notes that a number of cases have invalidated such provisions as "antiassignment." In re Jamsesway Corp, 201 B.R. 73, 78 (Bkrtcy. S.D.N.Y. 1/30/96); Rob III v. Schindler, 142 B.R. 589 (D. Mass 1992); In re Standor Jewelers West, Inc., 129 B.R. 200 (9th Cir. BAP 1991).

Comment 3: Although the editor lacks the benefit of the full opinion, the editor's reaction to the case is that it is generally unsurprising that that it can and should be distinguished away from cases in which there is a real change in the percentage rent performance of the prior tenant or some other interference in the operating strategy of the shopping center. The editor, however, would require that the percentage rent requirement be imposed on the basis of the rent generated by all the space, and not just those of the master assignee (in this case Staples). It is up to that party to draft subleases that cover its exposure here. Aside from that interpretation, however, the editor believes that a requirement that the store remain exactly as it was when it failed is in fact inconsistent with the free assignability contemplated by the Bankruptcy Code when the landlord cannot show that such requirement is necessary to preserve the cohesiveness of the center as a whole.

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