The Debts of the Lenders: Commercial Real Estate Landlords Exacerbate Bankruptcy Wave

=DJ Landlords Suffer Consequences Of 2005 Bankruptcy-Law Change

By Rachel Feintzeig Of DOW JONES NEWSWIRES

Three years after succeeding in a long-standing quest to gain more control over their leases during bankruptcy proceedings, landlords may now be finding that too much power can, in fact, be a bad thing.

Their lobbying efforts have inadvertently exacerbated the toughest real-estate market in years, according to a number of experts, by propelling companies in bankruptcy toward rushed liquidations that have left hundreds of stores dark. And the irony has not been lost on those in the bankruptcy community.

"Be careful what you wish for," said Richard Levin, a partner in Cravath, Swaine & Moore LLP's restructuring department. "You may get it."

(This article also appears in Daily Bankruptcy Review, a publication from Dow Jones & Co.)

When Congress overhauled the Bankruptcy Code in 2005, big landlords and mall owners pushed for a provision that set a 210-day deadline for companies in bankruptcy to decide whether to assume a lease, incorporating that location into its reorganization efforts, or to reject it, in which case it must pay to free itself from the contract.

Many restructuring experts, including bankruptcy lawyers who represent debtor companies, tried to block the change, arguing that retailers needed to get through an entire business cycle - including the critical holiday shopping period - to decide which stores were worth salvaging.
But landlords were growing tired of being strung along by retailers who dallied in Chapter 11, delaying the decisions on their leases and leaving property owners in limbo. Mall operators in that situation couldn't actively seek new tenants, but they had to constantly brace for the possibility that their monthly rent checks would stop coming with little notice.

The landlords succeeded in getting Congress to add a provision to the Bankruptcy Abuse and Consumer Protection Act that requires companies to make a decision on their leases within 210 days, after which point bankruptcy courts are powerless to intervene with additional extensions. The lease-rejection deadline was a huge win for landlords, or so they thought in 2005.

"We were writing a Bankruptcy Code at that time in a lending environment where liquidity was aplenty and access to capital and funds was easy and cheap," said Jack Williams, the resident scholar at the American Bankruptcy Institute. "[The landlords] were thinking if [tenants] don't pay me, there are 100 retailers out there that will fill that space just as quickly as they can."
Now, with retailers drowning in bankruptcy, prominent members of the corporate restructuring community are asking Congress to roll back the change.

"Nobody could have predicted what was going to happen," said Richard Pachulski, an attorney with Pachulski Stang Ziehl & Jones LLP.

The financial crisis that started in 2007 with the collapse of the subprime mortgage market took down the real estate and retail industries in 2008. A steep decline in consumer spending coupled with plunging real-estate prices have dealt shopping centers across the country a one-two punch. Malls have seen a record number of store closings - 6,913 in 2008 alone, according to the International Council of Shopping Centers.

Big landlords are now finding that they're the ones in financial trouble. General Growth Properties Inc. (GGP), which owns and manages more than 200 malls in the U.S., is negotiating with its creditors to stave off bankruptcy and to restructure its $27 billion debt load out of court. Malls owned by Westfield Group are reducing business hours in an attempt to counteract sinking demand.

"I don't think they thought through this process," Williams said of the landlords who lobbied for the changes.

General Growth and Simon Property Group Inc. (SPG), another big mall operator, declined to comment. Representatives for Westfield didn't return calls seeking comment.

Liquidation has claimed a long list of big retailers over the past year. The carcasses of retailers like Circuit City Stores Inc. (CCTYQ), Linens 'n Things Inc., Steve & Barry's and Sharper Image Corp. (SHRPQ) litter nearly every mall and shopping center in America. And by speeding up the liquidation process, some say the 210-day deadline has come back to haunt the property owners that lobbied for it.

Faced with the new time constraints, retailers are casting off properties they're unsure of rather than taking a chance in a recession. The lease deadline, combined with other pro-creditor
Bankruptcy Code changes, is causing already skittish lenders to insist on restrictive bankruptcy-loan terms that may prematurely force some retailers into liquidation.

Some lenders are requiring retailers to hit high sales targets or to find a buyer at breakneck speed. Experts say lenders are taking such precautions to ensure they'll be able to liquidate their collateral, the inventory, within the 210-day period if an attempt at reorganization fails - as most have recently. After all, a retailer needs to stay in its stores to conduct a successful going-out-of-business sale; out-of-store liquidations yield far lower recoveries for creditors.
That means lenders are keeping retailers on a leash, giving them just a short amount of time - much shorter than the 210 days officially allotted by the Bankruptcy Code - to save a sinking ship.

"What [the landlords] didn't anticipate was that people were going to take this ultimate limit on the lease assumption and back up at least 90 days," said Holly Etlin, a turnaround professional with AlixPartners.

Pachulski said lenders have latched on to the reduced timeframe because it's the perfect pretense for speeding up a bankruptcy case. Banks are "looking to any excuse to force a liquidation," he said.

The landlords insist that they're willing to be flexible; it's the banks, they say, that are making restructuring more difficult. David Pollack, an attorney who frequently represents landlords in retail bankruptcy cases, says most property owners are willing to extend the 210-day period. In the Linens 'n Things bankruptcy, for example, 93% of the company's landlords granted extensions. But the home-goods retailer went out of business anyway.

"The landlords are going to be realistic," said Pollack, a partner at Ballard, Spahr, Andrews & Ingersoll LLP. "The question is if the lenders are going to be realistic."
Like most of the landlords he represents, Pollack opposes rolling back the 2005 revisions to the Bankruptcy Code. "Things don't need to change," Pollack said. The amendments, he says, have "absolutely nothing" to do with retailers' struggles in bankruptcy court.

But prominent members of the bankruptcy and restructuring community disagree and are urging Congress to roll back some of the 2005 changes, including the 210-day lease deadline.
Last week, the House Judiciary Committee's Subcommittee on Commercial and Administrative Law heard from a few of these lawyers and advisers to troubled companies at a hearing on the collapse of Circuit City. Some argued that the lease change helped put the massive retailer out of business and put more than 30,000 people out of work as a result.

Harvey Miller, who heads the bankruptcy practice at Weil, Gotshal & Manges, said the "balancing of interests" enacted by the Bankruptcy Code more than 30 years ago has been upset by the amendments fought for and won by special-interest groups, like landlords.
The 2005 changes "fulfilled a long-standing desire on the part of special-interest groups to limit the discretion of the bankruptcy court and thereby reduce the flexibility of the court to meet the needs of rehabilitation and reorganization of a debtor," Miller said in his written testimony to Congress.

But Developers Diversified Realty (DDR) President Daniel B. Hurwitz says the impact of the 210-day deadline "has been insignificant." Hurwitz testified at last week's hearing on behalf of the International Council of Shopping Centers, which is opposed to eliminating the 210-day lease deadline.

"The greatest impact to the retail landscape today is the lack of liquidity from lenders and onerous terms from vendors," Hurwitz said in a statement provided to Dow Jones after the hearing.

Many restructuring professionals remain convinced the landlords know the provision is hurting them but can't bring themselves to give up their hard-fought victory.

"I think it's part of the human condition, once you got something and you only got it a few years ago, it's hard to give it up," said Williams, who's also a professor at the Georgia State University College of Law.

Cravath's Levin agreed, suggesting that the landlords are willing to let some of their own suffer to keep their newfound control.
"They may be trying to sacrifice a few to save the principle," he said.

-By Rachel Feintzeig, Dow Jones Newswires; 202-862-1358; rachel.feintzeig@dowjones.com

(END) Dow Jones Newswires
03-20-09 1311ET