BAPCPA: Another Nail in the Coffin of Retail Reorganizations

In contrast to the extensive coverage, including congressional hearings, generated by the restrictions on courts' discretion to extend time, the limitation on courts' discretion to invalidate use clauses has generated limited coverage. With darkened stores presently casting a shadow over shopping centers, landlords are unlikely to risk another vacancy. In the one case addressing BAPCPA's limitation on assignment, an owners' association ' not the landlord ' objected to the assignment. Furthermore, unlike the restriction on extending time, the statute's language and very limited case law fail to provide a definitive answer whether a court has discretion to modify a useless use clause. With the recent improvement in retail sales and the increasingly optimistic economic outlook, the demand for shopping center space may rebound in the near future. Thus, many debtors may soon be faced with uncertainty over how courts will address the useless use clause and whether they can monetize their valuable assets within the limited time provided by the statute.

Pre BAPCPA

The assumption and assignment of a lease may be one of a retail debtor's most valuable assets. Congress provided “the assumption and assignment of unexpired leases as a means of assisting the debtor in its reorganization or liquidation efforts.” In re Jamesway Corp., 201 B.R. 73, 77-78 (Bankr. S.D.N.Y. 1996). To facilitate this important right, Congress invalidated anti assignment clauses. The statute provided “notwithstanding a provision.. that prohibits, restricts, or conditions the assignment ' the trustee may assign such contract or lease.” 11 U.S.C. ' 365(f)(1).

However, Congress tempered the debtor's ability to assume and assign shopping center leases and protected the shopping center landlords and the other shopping center tenants from breaches of lease clauses that would prejudice their unique interests. Congress recognized that a shopping center is a carefully planned enterprise where the tenant mix may be as important as the fixed monthly rent payments to the landlord. Additionally, other shopping center tenants are impacted by the tenant mix and exclusivity. Thus, the statute required adequate protection regarding the lease provisions of a shopping center lease, including the use provisions.

Section 365(b)(3) of the Bankruptcy Code provided adequate assurance of future performance for shopping centers, including that assumption or assignment will not “(C) breach any provision, such as a radius, location, use, or exclusivity provision ' or (D) disrupt any tenant mix or balance.” The legislative history stated that “[t]his amendment requires strict compliance with the provisions of use clauses in shopping center leases and prohibits any changes in the use of the tenant's space not permitted by the use clause.” 130 Cong. Rec. S8895 (June 29, 1984). Thus, the 1984 Amendment appeared to require strict compliance with the provisions of use clauses.

Despite the language of the pre BAPCPA statute and the Congressional record, most courts found that useless use clauses were de facto anti-assignment clauses and, as such, unenforceable. As the Third Circuit explained, “[e]ven under the tightly drawn definition of 'adequate assurance' in the shopping center context, Congress did not envision literal compliance with all lease provisions ' ” In re Joshua Slocum Ltd., 922 F.2d 1081, 1090 (3d Cir. 1990).

In Re Rickel Home Centers Inc.

In In Re Rickel Home Centers Inc., a widely cited case, the court excised the useless use clauses requiring the properties be operated as home improvement centers and, as such, allowed the stores to be assigned to Staples. 240 B.R. 826, 831-32 (D. Del. 1999). Rickel explained that the model home improvement center has “either become obsolete or is struggling to remain in existence, as a result of the advent of warehouse type home improvement stores like Home Depot” and “given that the market for such centers is either non-existent or in dire straits, such use restrictions would make it impossible for the Debtor to assign them.” Id. at 831.

Rickel is consistent with the Code's purpose ' to protect the unique interests of landlords and the other shopping center tenants. A particular use may be critical to attract customers or increase percentage rental revenue. However, a useless use clause provides neither the landlords nor co-tenants with any of these benefits. The only benefit would appear to be that enforcement allows the landlord to profit from the underwater lease, an asset that rightfully belongs to the debtors. Not surprisingly, the majority of case law on the issue follows Rickel.

One exception to this trend was seen in the Fourth Circuit. In the case of In re Trak Auto Corp., 367 F.3d 237 (4th Cir. 2004), both the bankruptcy court and the district court found that the “market in the area is saturated and 'cannot bear [the] restriction' limiting use to the sale of auto parts and accessories.” Id. at 244. The Fourth Circuit found that the lower court overlooked that the landlord “made the judgment that an auto parts retailer is important to a successful mix of stores in the center” and noted that “Congress's purpose in ' 365(b)(3)(C) is to preserve the landlord's bargained-for protections with respect to premises use and other matters that are spelled out in the lease ' ” Id. However, the Fourth Circuit failed to explain how a successful mix of stores includes a lease burdened by a useless use clause. Not surprisingly, the reasoning in Trak was not widely adopted by courts in other circuits. Some believe, however, that BAPCPA codifies Trak into the statute.

Shopping Center Leases

BAPCPA subjected the courts' ability to modify use clauses to the section providing adequate protection for shopping center leases. (See ' 365(f)(1) as amended; “except as provided in subsections (b)”). “Section 404(b) amends ' 365(f)(1) to assure that '365(f) does not override any part of ' 365(b). Thus, ' 404(b) makes a trustee's authority to assign an executory contract or unexpired lease subject not only to ' 365(c), but also to ' 365(b), which is given full effect. Therefore, for example, assumption or assignment of a lease of real property in a shopping center must be subject to the provisions of the lease, such as use clauses.” H.R. Rep. No. 109-31, pt. 1, at 87, reprinted in 2005 U.S. Code Cong. & Admin. News 153.

Three A's

In re Three A's Holdings, addressed the effect of BAPCPA on the assumption and assignment of shopping center leases. 364 B.R. 550 (Bankr.D.Del.2007). There, the debtor, Tower Records, sought to assign its lease in a shopping district to Walgreens. The property was subject to restrictive use covenants, permitting 46 allowed uses. The owners' association objected to the assignment alleging Walgreens' proposed use violated the relevant covenants. Three A's found that the assignment violated the lease clause and, as such, did not allow the assignment. Id. at 560. Three A's noted that “BAPCPA ' further constrained the court's ability to authorize assumption or assignment of shopping center leases in violation of the terms of such leases by expressly subjecting section 365(f)(1) to the provisions of section 365(b)(3).” Id. at fn#2. Thus, some have concluded that in light of BAPCPA and the Three A's holding, courts lack the discretion to invalidate use clauses.

Did BAPCPA Remove Courts' Discretion?

While it may appear that BAPCPA eliminated the courts' discretion to modify useless use clauses, examination of pre-BAPCPA case law indicates that courts may still continue to excise certain use clause. As discussed, the 1984 Amendment appeared to have removed the courts discretion. Nevertheless, after 1984, courts continued to invalidate useless use clauses. Even Trak found that “the Congress did not intend to make ' 365(f)(1) completely inapplicable to shopping center leases.” Trak, 367 F.3d, at 245. Thus, based upon pre-BAPCPA jurisprudence, courts may continue to modify useless use clauses.

Moreover, Three A's is at best only dicta. There, the development agreement allowed 46 permitted uses. Three A's, 364 B.R. at 555. The court never addressed whether the relevant use clause was a de facto anti-assignment clause. In light of 46 permitted uses, the court may well have ruled under the pre-BAPCPA statute that the use clause was enforceable. Furthermore, the discussion of the effects of BAPCPA was in a footnote. Finally, the court never addressed how BAPCPA affected its decision or BAPCPA's effect on the Third Circuit's pre-BAPCPA jurisprudence.

Another Chilling Effect

Strict enforcement of lease provisions would have another chilling effect on the assumption or assignment of leases. Many leases have continuous use provisions requiring the tenant remain open and not go dark. A strict interpretation of the statute would in all likelihood impede the assignment of many leases containing a continuous use clause. A debtor or assignee would be prevented from going dark during the transition to a new store or a new model. Thus, a strict reading of the statute may well prevent the reengineering of failed stores.

Conclusion

As the statute has not been interpreted by the courts, a debtor whose property includes leases burdened with useless use clauses is faced with uncertainty. Prior to BAPCPA, a debtor could look to Trak or Rickel to select an appropriate venue. As discussed, it is unclear to what extent BAPCPA has effected courts' discretion regarding useless use clauses. Prior to BAPCPA, it appeared that Congress limited the courts' discretion to modify useless use clauses. Nevertheless, most courts excised useless use clauses. Likewise, under BAPCPA, courts may still exercise their discretion and modify useless clauses. (It is likely that this discretion may be somewhat more constrained in light of BAPCPA.) Thus, a debtor may very well benefit from seeking guidance from pre-BAPCPA decisions regarding shopping center leases.

Yitzhak Greenberg is currently associated with the Law Offices of Gabriel Del Virginia in New York. He can be reached at [email protected].

The Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) has had a profound effect on retail reorganizations, particularly, the restriction on bankruptcy courts' broad discretion to extend debtors' time to assume or reject leases. This shortened time period, a maximum of 210 days, has been alleged to be responsible for the death of retail reorganizations. Did BAPCPA further impact the debtor/landlord relationship ' by limiting the right to assign shopping center leases burdened by a clause requiring a use that either no longer exists or is economically unfeasible, e.g., Saturn dealerships, video rentals, beeper sales or typewriter repairs (“useless use clause”)? Under BAPCPA, courts' discretion to invalidate useless use clauses may be severely constrained. This dynamic combination of the time limitations and the strict enforcement of use clauses may effectively terminate many retail debtors' ability to assume or assign leases.

Prior to BAPCPA, courts considered these clauses de facto anti-assignment clauses and, as such, not enforceable. While 11 U.S.C. ' 365(b)(3) required adequate protection for the assumption of a shopping center lease (including use clauses), many courts balanced the rights of the debtor and shopping center landlords, excising useless use clauses pursuant to ' 365(f)(1)(addressing anti-assignment clauses). BAPCPA amended ' 365(f)(1) subjecting courts' discretion to modify use clauses to ' 365(b)(3) and, as such, many concluded that BAPCPA required strict compliance with shopping center lease use clauses, even useless use clauses. However, an analysis of the pre BAPCPA statute demonstrates that courts have liberally interpreted limitation on their discretion regarding shopping center leases. Thus, under BAPCPA, courts may continue to invalidate useless use clauses.

Limitation on Courts' Discretion

In contrast to the extensive coverage, including congressional hearings, generated by the restrictions on courts' discretion to extend time, the limitation on courts' discretion to invalidate use clauses has generated limited coverage. With darkened stores presently casting a shadow over shopping centers, landlords are unlikely to risk another vacancy. In the one case addressing BAPCPA's limitation on assignment, an owners' association ' not the landlord ' objected to the assignment. Furthermore, unlike the restriction on extending time, the statute's language and very limited case law fail to provide a definitive answer whether a court has discretion to modify a useless use clause. With the recent improvement in retail sales and the increasingly optimistic economic outlook, the demand for shopping center space may rebound in the near future. Thus, many debtors may soon be faced with uncertainty over how courts will address the useless use clause and whether they can monetize their valuable assets within the limited time provided by the statute.

Pre BAPCPA

The assumption and assignment of a lease may be one of a retail debtor's most valuable assets. Congress provided “the assumption and assignment of unexpired leases as a means of assisting the debtor in its reorganization or liquidation efforts.” In re Jamesway Corp., 201 B.R. 73, 77-78 (Bankr. S.D.N.Y. 1996). To facilitate this important right, Congress invalidated anti assignment clauses. The statute provided “notwithstanding a provision.. that prohibits, restricts, or conditions the assignment ' the trustee may assign such contract or lease.” 11 U.S.C. ' 365(f)(1).

However, Congress tempered the debtor's ability to assume and assign shopping center leases and protected the shopping center landlords and the other shopping center tenants from breaches of lease clauses that would prejudice their unique interests. Congress recognized that a shopping center is a carefully planned enterprise where the tenant mix may be as important as the fixed monthly rent payments to the landlord. Additionally, other shopping center tenants are impacted by the tenant mix and exclusivity. Thus, the statute required adequate protection regarding the lease provisions of a shopping center lease, including the use provisions.

Section 365(b)(3) of the Bankruptcy Code provided adequate assurance of future performance for shopping centers, including that assumption or assignment will not “(C) breach any provision, such as a radius, location, use, or exclusivity provision ' or (D) disrupt any tenant mix or balance.” The legislative history stated that “[t]his amendment requires strict compliance with the provisions of use clauses in shopping center leases and prohibits any changes in the use of the tenant's space not permitted by the use clause.” 130 Cong. Rec. S8895 (June 29, 1984). Thus, the 1984 Amendment appeared to require strict compliance with the provisions of use clauses.

Despite the language of the pre BAPCPA statute and the Congressional record, most courts found that useless use clauses were de facto anti-assignment clauses and, as such, unenforceable. As the Third Circuit explained, “[e]ven under the tightly drawn definition of 'adequate assurance' in the shopping center context, Congress did not envision literal compliance with all lease provisions ' ” In re Joshua Slocum Ltd., 922 F.2d 1081, 1090 (3d Cir. 1990).

In Re Rickel Home Centers Inc.

In In Re Rickel Home Centers Inc., a widely cited case, the court excised the useless use clauses requiring the properties be operated as home improvement centers and, as such, allowed the stores to be assigned to Staples. 240 B.R. 826, 831-32 (D. Del. 1999). Rickel explained that the model home improvement center has “either become obsolete or is struggling to remain in existence, as a result of the advent of warehouse type home improvement stores like Home Depot” and “given that the market for such centers is either non-existent or in dire straits, such use restrictions would make it impossible for the Debtor to assign them.” Id. at 831.

Rickel is consistent with the Code's purpose ' to protect the unique interests of landlords and the other shopping center tenants. A particular use may be critical to attract customers or increase percentage rental revenue. However, a useless use clause provides neither the landlords nor co-tenants with any of these benefits. The only benefit would appear to be that enforcement allows the landlord to profit from the underwater lease, an asset that rightfully belongs to the debtors. Not surprisingly, the majority of case law on the issue follows Rickel.

One exception to this trend was seen in the Fourth Circuit. In the case of In re Trak Auto Corp., 367 F.3d 237 (4th Cir. 2004), both the bankruptcy court and the district court found that the “market in the area is saturated and 'cannot bear [the] restriction' limiting use to the sale of auto parts and accessories.” Id. at 244. The Fourth Circuit found that the lower court overlooked that the landlord “made the judgment that an auto parts retailer is important to a successful mix of stores in the center” and noted that “Congress's purpose in ' 365(b)(3)(C) is to preserve the landlord's bargained-for protections with respect to premises use and other matters that are spelled out in the lease ' ” Id. However, the Fourth Circuit failed to explain how a successful mix of stores includes a lease burdened by a useless use clause. Not surprisingly, the reasoning in Trak was not widely adopted by courts in other circuits. Some believe, however, that BAPCPA codifies Trak into the statute.

Shopping Center Leases

BAPCPA subjected the courts' ability to modify use clauses to the section providing adequate protection for shopping center leases. (See ' 365(f)(1) as amended; “except as provided in subsections (b)”). “Section 404(b) amends ' 365(f)(1) to assure that '365(f) does not override any part of ' 365(b). Thus, ' 404(b) makes a trustee's authority to assign an executory contract or unexpired lease subject not only to ' 365(c), but also to ' 365(b), which is given full effect. Therefore, for example, assumption or assignment of a lease of real property in a shopping center must be subject to the provisions of the lease, such as use clauses.” H.R. Rep. No. 109-31, pt. 1, at 87, reprinted in 2005 U.S. Code Cong. & Admin. News 153.

Three A's

In re Three A's Holdings, addressed the effect of BAPCPA on the assumption and assignment of shopping center leases. 364 B.R. 550 (Bankr.D.Del.2007). There, the debtor, Tower Records, sought to assign its lease in a shopping district to Walgreens. The property was subject to restrictive use covenants, permitting 46 allowed uses. The owners' association objected to the assignment alleging Walgreens' proposed use violated the relevant covenants. Three A's found that the assignment violated the lease clause and, as such, did not allow the assignment. Id. at 560. Three A's noted that “BAPCPA ' further constrained the court's ability to authorize assumption or assignment of shopping center leases in violation of the terms of such leases by expressly subjecting section 365(f)(1) to the provisions of section 365(b)(3).” Id. at fn#2. Thus, some have concluded that in light of BAPCPA and the Three A's holding, courts lack the discretion to invalidate use clauses.

Did BAPCPA Remove Courts' Discretion?

While it may appear that BAPCPA eliminated the courts' discretion to modify useless use clauses, examination of pre-BAPCPA case law indicates that courts may still continue to excise certain use clause. As discussed, the 1984 Amendment appeared to have removed the courts discretion. Nevertheless, after 1984, courts continued to invalidate useless use clauses. Even Trak found that “the Congress did not intend to make ' 365(f)(1) completely inapplicable to shopping center leases.” Trak, 367 F.3d, at 245. Thus, based upon pre-BAPCPA jurisprudence, courts may continue to modify useless use clauses.

Moreover, Three A's is at best only dicta. There, the development agreement allowed 46 permitted uses. Three A's, 364 B.R. at 555. The court never addressed whether the relevant use clause was a de facto anti-assignment clause. In light of 46 permitted uses, the court may well have ruled under the pre-BAPCPA statute that the use clause was enforceable. Furthermore, the discussion of the effects of BAPCPA was in a footnote. Finally, the court never addressed how BAPCPA affected its decision or BAPCPA's effect on the Third Circuit's pre-BAPCPA jurisprudence.

Another Chilling Effect

Strict enforcement of lease provisions would have another chilling effect on the assumption or assignment of leases. Many leases have continuous use provisions requiring the tenant remain open and not go dark. A strict interpretation of the statute would in all likelihood impede the assignment of many leases containing a continuous use clause. A debtor or assignee would be prevented from going dark during the transition to a new store or a new model. Thus, a strict reading of the statute may well prevent the reengineering of failed stores.

Conclusion

As the statute has not been interpreted by the courts, a debtor whose property includes leases burdened with useless use clauses is faced with uncertainty. Prior to BAPCPA, a debtor could look to Trak or Rickel to select an appropriate venue. As discussed, it is unclear to what extent BAPCPA has effected courts' discretion regarding useless use clauses. Prior to BAPCPA, it appeared that Congress limited the courts' discretion to modify useless use clauses. Nevertheless, most courts excised useless use clauses. Likewise, under BAPCPA, courts may still exercise their discretion and modify useless clauses. (It is likely that this discretion may be somewhat more constrained in light of BAPCPA.) Thus, a debtor may very well benefit from seeking guidance from pre-BAPCPA decisions regarding shopping center leases.

Yitzhak Greenberg is currently associated with the Law Offices of Gabriel Del Virginia in New York. He can be reached at [email protected].