Originally published in the American Bankruptcy Institute Journal, September 2018.
Shopping centers are a delicate blend of stores and services, carefully crafted at the hand of the master mixologist: the landlord. However, if a landlord doesn’t take certain precautions, it may lose its right to control the balance of the ingredients to this cocktail: the tenant mix. On May 30, 2018, Eastern District of Virginia Bankruptcy Judge Keith Phillips ruled that a landlord in Brea, Calif., could not rely on 11 U.S.C. § 365(b)(3)(C) and (D) to prevent Toys “R” Us (TRU) from assigning its lease to Burlington Coat Factory, LLC. This opinion makes clear that a landlord cannot rely on use restrictions in leases with third-party tenants, or undefined notions of tenant mix, to prevent the assumption of a lease in a bankruptcy case.
On the petition date, TRU leased space in Brea Union Plaza. During the bankruptcy case, TRU auctioned unexpired leases to buyers for assumption and assignment. TRU sought court approval to assign the lease to Burlington. Brea Union Plaza I LLC, the Brea Union Plaza landlord, in an effort to preserve its delicately balanced shopping center cocktail, objected to the assignment on two bases: (1) The assignment would cause Brea to violate a restriction contained in a lease with Ross Dress For Less, Inc., a nonparty tenant in the same center; and (2) allowing Burlington to become a tenant of Brea Union Plaza would disrupt the tenant mix.
11 U.S.C. § 365(b)(3)(C): Assumption and Assignment Must Not Breach Other Leases
In October 2009, the landlord executed a lease with Ross for retail space at Brea Union Plaza to sell “off-price” clothing, which prohibited Brea from leasing any space in Brea Union Plaza to any other retailer that would use the premises for “off-price sales.” Brea argued that allowing Burlington, an “off-price” retailer, to assume TRU’s lease would cause Brea to violate the Ross lease. The landlord relied on 11 U.S.C. § 365(b)(3)(C), which requires adequate assurance that the assumption and assignment of a lease will not breach the provisions contained in any other lease, and on case law to argue that “the assignment must not breach a restriction in any other lease.”
The court found that § 365(b)(3)(C) did not support Brea’s contention because its purpose was to protect a landlord’s expectations under the debtor-tenant’s lease and was not meant to protect nonparty tenants. Further, distinguishing In re Heilig-Meyers Co., cited by Brea, the court found that the lease in this case contained no provision prohibiting Brea from assigning its lease to any entity that would cause Brea to violate a noncompete agreement with any other tenant. Finally, the court determined that the assignment of the lease to Burlington did not breach the exclusivity provision in the Ross lease because the provision in question only applied if the landlord had “the capacity to [honor its exclusivity clause].” The court explained that assigning a lease is a judicial action that may render a landlord unable to comply with a restriction in a nonparty tenant’s lease. The court’s assignment of TRU’s lease to Burlington would render Brea without the capacity to enforce the exclusivity provision of the Ross lease.
11 U.S.C. § 365(b)(3)(D): Assumption and Assignment Must Not Disrupt Tenant Mix
Brea then argued that allowing Burlington to assume the lease would disrupt the tenant mix, because two “off-price” retailers already leased space at Brea Union Plaza and allowing a third would disrupt the balance of the tenants. Brea relied on 11 U.S.C. § 365(b)(3)(D), which requires adequate assurance that the assumption and assignment of a lease “will not disrupt any tenant mix or balance.” The court found that § 365(b)(3)(D) did not support Brea’s argument, as it refers to “contractual protections and not undefined notions of tenant mix.” Since the tenant mix and balance was not contractually defined in the lease or any other master lease, Brea failed to establish how a third “off-price” apparel retailer in a shopping center with 43 tenants would disrupt the tenant mix.
This opinion should serve as a cautionary tale for any landlord who, naturally, desires to engineer its own recipe for its shopping center concoction. However, this case is not the first of its kind. A Southern District of New York court ruled that a court order assigning an unexpired lease would excuse a landlord from breaching other tenants’ leases. This New York court reasoned that a court order would make it legally impossible for a landlord to perform provisions of nonparty leases.A Middle District of Tennessee Bankruptcy Court also held that because no provision in the debtor-tenant’s lease prohibiting particular uses of the leased space existed, the landlord could not rely on a “prohibited use” provision in a nonparty tenant’s lease to object to the sublease of the premises by the debtor-tenant.
As demonstrated by the TRU opinion, for a landlord to prevent the assignment of a lease, the adequate assurances of 11 U.S.C. § 365(b)(3) must stem directly from the debtor-tenant’s lease. Courts around the country have upheld provisions of a debtor’s lease for the purpose of protecting the landlord’s bargained-for benefit. Courts have protected these bargained-for benefits by, for example, upholding a restrictive-use clause in the debtor-tenant’s lease, refusing to expand a restrictive covenant because the court determined that the covenant was in place to preserve tenant mix, and even upholding a radius provision in the debtor-tenant’s lease, stating it was doubtful whether a court may alter terms of a lease for the purpose of assignment absent anti-assignment implications. These examples illustrate that the “bargained-for exchange” in the debtor-tenant’s lease must remain part of the lease upon assignment.
This may spur landlords to amend existing leases as a precautionary measure in the event any tenant files for bankruptcy. Although a landlord may not add purely anti-assignment provisions to leases, a landlord may amend leases to maintain certain characteristics in its carefully crafted shopping center cocktail. These amendments may include a description of allowable tenant mixes in order to give the landlord more control when objecting to assignments of leases, incorporation of a tailored noncompete agreement into the tenants’ leases to prevent situations like the TRU case, or incorporation of radius provisions, restrictive use clauses, or other provisions to better control who can assume debtor-tenant leases.