Are Commercial Lease Forbearance Agreements, for Tenant Defaults, Worth The Paper They are Written on?
The Landlord’s Business Goals for a Forbearance Agreement
- Downsides of terminating the Lease. Does the Landlord really want to terminate the Lease and get the Tenant out?
- In a bad leasing market, is the Landlord better-off getting some money from the Tenant? Is a good replacement tenant timely available?
- Would the Landlord have a better chance of eventually getting paid at least something if the Tenant continues as a going concern from the Leased Premises?
- Would the vacant space be an eyesore for the rest of the project?
- Can the Leased Premises be successful re-structured into a popular use? For example: converting retail space into an Amazon-type distribution center.
- Grandfathering – Would the replacement tenant’s use and occupancy permit application trigger expensive building upgrades?
- Tenant may argue, albeit a weak argument, that Landlord terminated in a way as to be an acceptance of a cancellation of the Lease.
- Getting paid something and some control over the Tenant’s other funds. To get some payment in hand, and/or at least to get the Tenant to commit more funds or dedication to the project, instead of on Tenant’s attorneys’ fees and other expenses of litigation.
- Arranging to get some specific payment later when possible. To get agreements extending payment due dates until the Tenant should be able to make them, including perhaps changing to percentage rent (even for office and professional Tenants). Adding percentage rent also gives the Landlord more justification to ask for more income reporting requirements and, thus, more information as to if and when the Tenant is recovering.
- Amending the Lease.
- Getting more collateral. To get more guaranties, collateral (like letters of credit), recourse liability, financial covenants and reports, and pledges of Uniform Commercial Code (“UCC”) security interests in the furniture, fixtures and equipment. The Landlord may want to file UCC financing statements if it has not already done so; but note the risks that, in some jurisdictions, such filings may trigger recordation and transfer taxes on the lease itself. The Landlord may also want to limit the salaries, distributions and other payments, to the Tenant’s insiders and related parties, during the forbearance period.
- Getting more flexibility. To get an ability where the Lease does not already provide it (1) to give notices by e-mail; (2) where the Lease does not allow the Landlord to unilaterally amend the rules and regulations therefore, to impose greater pandemic-related obligations upon the Tenant such as requiring the Tenant to report illnesses, to require the wearing of protective clothing, and to limit entries; (3) to gain clearer rights to limit entry to the Leased Premises and to close the building or center; (4) to require the Tenant to waive, release or assume the risks associated with a pandemic; (5) to require further business interruption insurance, including pandemic and lockdown protection; (6) to require the Tenant to operate in certain common areas; (7) to obtain greater rights of entry to show the Leased Premises to prospective replacement tenants; (8) to increase the frequency of percentage rent reports and payments; (9) to be sure that common area maintenance or operating costs include the extra costs associated with a pandemic, and that the base year for operating costs and controllable operating costs take into account the unusual COVID-19 period; (10) to refine the force majeure, operating hours, continuous occupancy, condemnation, and casualty clauses, and to provide specific rights and remedies for pandemics, mass refusals to work, and government-ordered shut-downs.
- Getting-back various concessions made in the Lease. Such as (1) to eliminate or modify extension options, expansion options, purchase rights, and subleasing and assignment rights, or the rights of subtenants or assignees to exercise them; (2) to gain recapture rights; (3) to gain more control over the Tenant’s exclusive or menu; (4) to gain relocation rights; (5) to limit or broaden any co-tenancy contingencies (such as to state that an Amazon-type of warehouse can be counted as a retail use) or to excuse closures of the other tenants due to force majeure; and/or (6) to limit further any common area or “zone of influence” use restrictions the Tenant may have.
- Remedying any monetary concessions granted in the forbearance agreement. Add specific requirements related to any monetary concessions that the Landlord grants in the forbearance agreement. Such as requiring that the Tenant apply for any and all loans, grants and business interruption proceeds, that may be applicable to the events giving rise to those concessions; that the Tenant keep the Landlord advised of such applications and proceeds; and that the monetary concessions made by the Landlord in the forbearance agreement shall not apply, to the maximum extent allowable by law or the insurance company, if and when Tenant receives any such proceeds, i.e. the Tenant shall immediately reimburse the Landlord, to the status quo ante, out of such proceeds, as a first priority.
- Getting updates. To update the Tenant’s representations and warranties, including as to any then pending litigation, and updated financial reports.
- Hoping to avoid or delay the Tenant’s filing Bankruptcy. The Landlord cannot delay or bar the Tenant from filing Bankruptcy (except, that, in some jurisdictions, a Tenant’s assignment for the benefit of creditors may be effective and may be better or worse for the Landlord). Therefore, in those jurisdictions, the Landlord needs to decide whether it would be better-off if the Tenant makes an assignment for the benefit of creditors. If the Tenant feels that a workable deal is likely, Tenant may not undertake the expense (including loss of funds via the payment of attorneys’, U.S. Trustee’s, and accounting fees), loss of control, and stigma that accompanies any such filing, and/or may agree to delay beyond Bankruptcy’s 90-day voidable preference period.
- Getting stipulations that may help in any subsequent eviction proceeding or Tenant Bankruptcy. To get the Tenant to stipulate to various items that may facilitate any subsequent litigation, such as (i) the identity of the lease documents, including all express and implied modification thereto by e-mail or other informalities; (ii) that those documents are, subject to the effects of the Tenant’s defaults thereinafter described and the Landlord’s remedies with respect to those defaults, binding and in full force and effect in accordance with their terms; (iii) that the Tenant’s representation and warranties therein are then still accurate and complete; (iv) that the Tenant is indeed in default (and specify those particular defaults, particularly as to any environmental problems, and, where not obvious the damage resulting therefrom), that the Tenant has received due, proper and full notice of those defaults and any and all opportunities to cure them, and that the Tenant has not effectuated any such cures; (v) that the Tenant is still liable for any and all specific prior defaults that may otherwise have been waived by Landlord’s acceptance of rent or inaction; (vi) to the dollar amount Tenant then owes and how much its then known continuing liability is; (vii) that the Tenant then has no factual bases upon which to assert any defenses, offsets, counterclaims, or any other actions against the Landlord, even if those defenses were otherwise allowed, and that the Tenant waives, and releases the Landlord and Landlord’s employees and agents from, any and all liabilities that the Tenant may otherwise be able to claim, as of the date of this agreement, for breach or other act or omission, whether then known or unknown and whether contingent or not contingent; (viii) that the Landlord is entitled to evict the Tenant, with the Tenant’s remaining liable for future rents, and to exercise all of the Landlord’s other remedies on account of such defaults; (ix) that, in light of the defaults, the Tenant waives, if and to the extent waivable, all protections afforded to the Tenant under any applicable anti-deficiency or one action laws or rules; (x) if applicable, Landlord has duly terminated the Lease, except that Tenant remains liable for unpaid past rent, and for future rent, under the terms of the Lease; (xi) in light of the defaults, the Tenant waives any clogging of the equity defenses the Tenant may otherwise have (especially as to any recapture rights); (x) that the forbearance agreement does not create a partnership; and (ix) representations of facts that will help defeat a duress defense.
- Enforcing forbearance agreements; back-fire risks.
- The Landlord should avoid taking so much control of the Tenant’s business that the Landlord becomes a partner of the Tenant.
- Defense of duress.
- Putting a time limit, upon the negotiations, by filing a complaint for eviction at the beginning of the negotiations.
- Incorporating the agreement in an order of court in an eviction proceeding, including provisions allowing the Landlord to obtain pre-signed or stipulated consent judgment orders for possession and damages if the Tenant violates that agreement.
- The Landlord cannot enforce an agreement by the Tenant not to file bankruptcy. A Bankruptcy Court may or may not enforce or, perhaps except as to specific factual matters, even treat as an estoppel, stipulations as to Bankruptcy issues (such as stipulations that any Bankruptcy filing would be in bad faith or waivers of the automatic stay). However, see above as to whether a Bankruptcy Court may defer to an assignment for the benefit of creditors.
- Even if the Tenant does not file Bankruptcy, a state court may claw-back, under state fraudulent transfer laws (1) the benefits the Landlord gained under the forbearance agreement (therefore, the Landlord may want to make concessions in the forbearance agreement and needs to watch the severability boilerplate in that agreement); and, although unlikely, even possibly (2) the normal, scheduled prior rent payments. A claw-back can be particularly messy if the Court orders it after the parties have acted in reliance upon the forbearance agreement.
2. The Tenant’s Business Goals for a Forbearance Agreement
- RENT RELIEF and perhaps, for a retail Tenant, relief from certain operating hours, exclusives and radius clauses.
- In states that allow the Landlord to exercise self-help, having the Landlord covenant not to exercise that remedy.
- The Tenant may want to use various common areas for its operations.
- The Tenant may want to move to a better location in the subject project.
- Getting information as to whether the Landlord may file a Bankruptcy for itself or an involuntary Bankruptcy against the Tenant.
- Would the rent relief trigger at least some cancellation of indebtedness income under 26 U.S.C. §108? If so, timing may be an issue.
3. General Tenants’ Rights and Defenses That Provide Incentives for the Landlord to Negotiate a Forbearance Agreement
- Tenant can file Bankruptcy at any time. Regardless of what a foreclosure agreement says, the Tenant can always file for Bankruptcy, except possibly as referenced above regarding assignments for the benefit of creditors. (Paragraph 5 below deals with the consequences of a tenant bankruptcy. Paragraph 6 below deals with whether the Landlord can keep the Lease out of a tenant Bankruptcy Estate.)
- Governmental restrictions. Legislative restrictions and court closures or delays may delay the Landlord from obtaining remedies, particularly judicial ones.
- Force majeure clause of the Lease; impossibility, impracticality, frustration and constructive eviction defenses at common law. Is a carve-out, in the force majeure clause of a lease for rent, itself subject to the common law defenses? Tenants are seeking, as remedies, non-liability for rent and even termination. Hitz Restaurant Group; Victoria Secret.
- Any default of Landlord or failure of contingencies. For example: Co-tenancy contingency or Landlord’s obligations to open, provide or maintain? Even with a lease that contains an integration clause, a tenant will look for ways to find breaches of an implied covenant of good faith and fair dealing.
- Acceptance of possession defense. A Tenant who has vacated the Leased Premises may argue that the Landlord has accepted that Tenant’s surrender of the Leased Premises, and that no future rent is thereafter due, if the Landlord thereafter uses the Leased Premises for Landlord’s own purposes, thereafter sells the Leases Premises (which may include a foreclosure, deed in lieu of foreclosure or sale-leaseback), or relets for a period longer than the then remaining term of the Lease. However, if the Lease specifically provides that there is no acceptance of possession in any of those instances, then that provision will probably be honored by a court.
- Landlord needs to assure potential replacement tenants. If the Landlord does regain possession, the Landlord will probably need to indemnity any replacement tenant against any problems from the [former] Tenant or the [former] Tenant’s creditors, particularly as to the risks of any claw-backs described herein. Therefore, the Landlord will want to find the safest way of eliminating any potential future claims.
4. Risks of Negotiating a Forbearance Agreement
- Vis-à-vis the Tenant. The Landlord needs to try to be sure that any forbearance agreement, or even any discussion thereof, does not, itself, create any unintended Landlord obligations, such creating enforceable expectations of waivers, delays, future forbearances, equal treatment as other tenants, or a co-tenancy contingency. Pre-negotiation correspondence should make it clear that there is to be no agreement, or reliance, unless and until a written agreement is signed, sealed and delivered by both parties; in this regard, it may be wise to specifically exclude any right to rely upon e-mails.
- Vis-à-vis the Tenant’s guarantors. The Landlord should assure that all of Tenant’s guarantors agree that their guaranties remain in full force and effect to the Lease, as the Lease is affected by the forbearance agreement.
- A Bankruptcy filing. If the jurisdiction allows the Landlord self-help, then, as described herein, the Tenant may be able to moot the negotiations by filing Bankruptcy.
- Vis-a-vie the Landlord’s lender.
- Approval. The Landlord’s loan or mortgage documents may require the prior written approval, of the Landlord’s lender, to various of the types of landlord concessions and other amendments described herein.
- Bad boy or springing guaranties. Most bad boy or springing guaranties, accompanying non-recourse loans to landlords, have carve-outs (1) if the Landlord/borrower commits various breaches of the mortgage documents, which may include, as stated above, granting such lease concessions and other amendments; or (2) if the Landlord or the Landlord’s guarantor admits that it is not able to pay its debts as they become due. Therefore, as to the latter, if and when asking for such approval, the Landlord and its guarantor obviously need to be very careful, even in an e-mail.
5. What is Likely to Happen if the Tenant Files for Bankruptcy
- For the first generally 210 days. If the Tenant wants its Bankruptcy proceeding to continue, it would appear that the Tenant is obligated to continue to pay the rents, as a super-priority, as they arise (but for a 60-day delay, at the beginning, which the Bankruptcy Court is likely to grant to the Tenant), from the date the Tenant files its Bankruptcy Petition until the date it assumes or rejects the Lease (generally 210 days). 11 U.S.C. §365(d)(3); Art and Architectural Books. That may result in payments being made almost as soon as the Landlord can get from a landlord/tenant court during eviction proceedings before it. However, some Bankruptcy Courts treat those rents as having the same priority as other administrative expenses, and/or otherwise being payable later in the Case, instead of as they become due under the Lease. Pier 1 Imports and Modell’s Sporting Goods. Each such treatment may result in non-payment if a plan of reorganization is never confirmed, i.e. the case is converted to a Chapter 7, or the Bankruptcy Estate is administratively insolvent, i.e. doesn’t have enough money to pay all of its administrative claims.
- Tenant’s ability to reject the Lease. During that 210-day period from the time the Tenant files its Bankruptcy Petition, the Tenant has practically the absolute right to reject, i.e. to terminate, the Lease. If the Tenant exercises that right, then, in addition to having a claim as an unsecured creditor for the pre-petition rent, the Landlord is entitled to post-petition rent. However (i) as stated above, only the rent for the period from the Bankruptcy Petition until the rejection or vacating date has priority as a super-administrative or administrative expense; and (ii) the amount of rent the Landlord is entitled for the post-rejection balance of the Lease is capped, and, therefore, is less than the amount the Landlord is generally likely to be entitled to receive in state court proceedings if the Landlord does not relet the Leased Premises. 11 U.S.C. §502.
- Risks of claw-backs. Some Bankruptcy Courts hold that a termination of a lease made before the tenant files its Bankruptcy Petition (i.e. pre-petition) is not a “transfer” for the purposes of the voidable preferences and fraudulent transfers provisions of the Bankruptcy Code. 11 USC §§ 547 and 548. However, some Bankruptcy Courts hold otherwise, even if the tenant agreed to it, the tenant received some (allegedly inadequate) consideration for it, and the tenant surrendered possession pre-petition. In re White. Therefore, as stated above, the Landlord may want to make concessions in the forbearance agreement and needs to watch the severability boilerplate in that agreement. A voidable preference challenge is available in Bankruptcy, but is not generally available in state court. Again, a claw-back can be particularly messy if the Court orders it after the parties have acted in reliance upon the forbearance agreement or termination.
- Risks associated with an assumption and assignments. If the Lease is in, or gets clawed-back into, the Bankruptcy Estate, the Landlord faces the risks that (i) the Tenant will assume the Lease, in which event Landlord may be left with only administrative claims for unpaid post-assumption rent in what may be a administratively insolvent Bankruptcy Estate (see above regarding the risks of an administratively insolvent Bankruptcy Estate and a conversion to a Chapter 7; only “adequate assurances”, of cure, compensation and future performance, are required for Tenant to assume the Lease; that and only “adequate assurance” of future performance is required of the assignee to assign; and a Bankruptcy Court is likely to find that “adequate assurances” are satisfied with far less than what the Landlord would require under the assignment provisions of the Lease); and (ii) if the Bankruptcy Court allows the Tenant to assign the Lease, the Bankruptcy Court may ignore various use and other restrictions that are deemed to be de facto anti-assignment clauses (subject to various limitations for “shopping centers”) to permit an assignment to an undesirable replacement tenant or use.
- Equitable subordination. If the Landlord gains too much control over the operation of Tenant’s business, then, in addition to the risk stated above of the Landlord’s being deemed a partner, the rent that the Landlord is entitled to receive under the Bankruptcy may be subordinated to unsecured creditors’ claims via equitable subordination. 11 U.S.C. §510(c); applied to leases in Allied Technology. Merely exercising veto power (particularly of the type customarily exercised by landlords) over certain business decisions of the Tenant, without actively participating in the day-to-day management of the Tenant’s business, is generally not enough; however, terminating officers and employees may be. Moreover, if the Landlord makes misrepresentations to the Tenant’s creditors, unless possibly where the claims are by the Trustee in the Bankruptcy where the Tenant joined-in the misrepresentations, then the rents may also become subject to equitable subordination. Pari delicto.
- Prior security interests. Under State law, does the Landlord have a prior perfected security interest as a landlord’s lien or via a perfected Uniform Commercial Code security interest? If so, the Landlord may enjoy the priorities of a secured creditor in the subject collateral.
- Substantive consolidation. A Bankruptcy Count can pierce the Debtor’s corporate veil to get at the assets of an affiliated entity. However, a Bankruptcy Court can also consolidated affiliated entities into in a Tenant Bankruptcy, or the Tenant may be added to their bankruptcies, such that all of the assets of all of the entities are available to satisfy all of the claims against any of them. However, Bankruptcy Courts are less likely to order a substantive consolidation if the party sought to be brought-in is not also bankrupt. Substantive consolidation is based upon the expectations of the debtor parties and the creditors in dealing with each other and the entanglements among the debtor entities. Therefore, it is based upon similar elements as piercing the corporate veil, but piercing is generally used to get at just the assets of a single related party. A substantive consolidation could be good or bad for the subject Landlord, depending, in part, upon whether the Leased Premises and the businesses thereon are better or worse than the other premises and their businesses proposed to be consolidated. Furthermore, inter-company claims among the consolidated entities are usually cancelled, by a substantive consolidation, thereby leaving more money for the other creditors such as the Landlord.
- Recharacterization. The Tenant may claim that its principals or affiliates have secured or unsecured loans. The Landlord may seek to have the Bankruptcy Court recharacterize those loans as the Tenant’s equity, thereby enhancing the Landlord’s changes of getting paid. A state court may pierce the corporate veil to make those principals liable for the Tenant’s obligations to the Landlord, but a Bankruptcy Court can do that, too, as well as consider recharacterization.
6. A Landlord’s Efforts to Keep the Lease Out of a Tenant’s Bankruptcy
Obviously, the foregoing factors affect the Landlord’s decision as to whether it wants to keep the Lease out of a Tenant’s Bankruptcy. For example, if the Landlord has no prospects of finding a replacement tenant and can live with the uncertainty and if the Bankruptcy Estate is solvent enough, the Landlord may be better-off with the possibilities of getting rent as an administration expense claim if the Tenant files Bankruptcy. If the Landlord decides that it rather keep the Lease out of a Tenant’s Bankruptcy, the best way the Landlord has, to try to accomplish that, is to terminate the Lease and evict the Tenant pre-petition; and the Landlord may want to do that as part of a foreclosure agreement. A lease, of nonresidential real estate, that is fully and finally terminated prior to the Tenant’s Bankruptcy filing, does not become part of the Tenant’s Bankruptcy Estate and is not subject to the automatic stay. 11 U.S.C. §§ 541(b)(2) and 362(b)(10). However (a) some Bankruptcy cases have denied that exclusion for a termination before the expiration of the natural term of the lease [Indiana Hotel Equities]; and (b) as stated above, such a termination will not necessarily prevent a claw-back or a substantive consolidation. Where the Bankruptcy Court recognizes such an exclusion, then, for a termination to be effective, the Tenant may not have any right, under State law, to redeem at the time the Tenant files its Bankruptcy Petition. The ways to try to cut-off any Tenant redemption rights are:
- Judicial eviction. That may mean that the sheriff has actually and finally evicted the Tenant. For example, D.C. allows a tenant to redeem the leased premises at least until the U.S. Marshall starts overseeing the removal of the Tenant’s personal property and perhaps longer. Consider state court closures and delays regarding evictions. Win jurisdictions where the Tenant has extended rights to redeem, Tenant can relatively easily and cheaply file a “bear bones” Bankruptcy Petition before the Landlord can complete the termination process. However, even a Subchapter V is expensive and time-consuming for the Tenant to maintain; and there are limitations upon how frequently a tenant may file bankruptcies, i.e. to continue to cycle between landlord/tenant court and a bankruptcy court. Therefore, even under the cases giving effect to a pre-petition termination, a persistent Landlord may ultimately succeed in keeping the Lease out of a Tenant Bankruptcy.
- Self-help eviction. Is self-help (i.e. locking-out the Tenant or cutting-off its utilities) legally available, and legally effective to cut-off all redemption rights, under the law of the state wherein the property is located? [In D.C., self-help is not legally available and attempting it can trigger counterclaims. Sarete.] May the Landlord cut-off utilities under local code, applicable insurance regulations and the Landlord’s mortgage? If self-help is available to the Landlord, the Landlord may be very tempted to try it as the only way to out-run the Tenant’s filing a Bankruptcy Petition.
- Forbearance agreement. The Tenant should be able to agree, in a foreclosure agreement, to voluntarily vacate the Leased Premises and to waive its redemption and other rights, while agreeing to remain liable for damages for future rents. Such an agreement may prove easier and faster to obtain, and avoid defenses, than a judicial foreclosure or self-help. However, as stated herein, such an agreement may be subject to duress, fraudulent transfer and voidable preference defenses and claims.
A forbearance agreement can help a Landlord achieve various goals, including helping the Landlord if the Landlord subsequently seeks eviction or the Tenant subsequently files Bankruptcy. However, in negotiating the forbearance agreement, the Landlord needs to be careful not to create problems for itself. A Tenant’s Bankruptcy can provide certain rent payment assurances to the Landlord, but also triggers various delays and risks. Those delays and risks may be problematic enough to be worth making concessions, in a forbearance agreement, to try to avoid. Particularly, since a Tenant bankruptcy triggers an automatic stay up-front and the other Bankruptcy delays and costs, it is recommended that the Landlord be pro-active whenever a Tenant stops or reduces its rent payments or it otherwise appears that the Tenant may be getting into trouble. The Landlord needs to weigh each item described above against the others. If the Landlord decides to try to keep the Lease out of a Tenant’s Bankruptcy, the best way may be to try to terminate the Lease pre-petition, perhaps as part of a forbearance agreement. In a state that permits the Landlord to exercise self-help, there may be a race between the Landlord’s exercising its self-help rights and the Tenant’s filing its Bankruptcy Petition.
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