Lease Assumption: What if the Store Has Gone “Dark”?

Androse Assoc. of Allaire, LLC v. Great Atlantic & Pacific Tea Co. (In re Great Atlantic & Pacific Tea Co.), 472 B.R. 666 (S.D.N.Y. 2012)

In A&P, the landlord objected to a debtor’s motion to assume the lease for a store that went “dark” prior to bankruptcy.  The district court upheld a bankruptcy court decision granting the debtor’s motion, finding that the debtor’s decision to retain a closed store was supported by sound business judgment and that the requirements for assumption were met, including a cursory consideration of the heightened scrutiny given to shopping center leases.

Supermarkets General Corporation was the original tenant under a 1986 lease with a term of 25 years.  It was acquired by Pathmark Stores, Inc., which in turn was acquired by A&P in 2007.  The leased store was considered an anchor store in Allaire Village Plaza.  A&P operated another store directly across the street.

Sometime in 2009 the leased store “went dark” (i.e. ceased operations, although the lease remained in effect).  This was permitted under the lease, since the tenant was required to open the store for business as a supermarket at the beginning of the lease, but was not “obligated to conduct, or to remain open for the conduct of, any business.”

The A&P companies, including the tenant under this lease, filed bankruptcy in December 2010.  Under the Bankruptcy Code, a debtor may assume or reject a lease.  The decision is within the business judgment of the debtor.  Under Section 365 of the Bankruptcy Code, as a condition of assuming a lease a debtor must cure (or provide adequate assurance of the prompt cure) of any existing defaults (with certain limited exceptions) and provide adequate assurance of future performance under the lease.

This lease was one of 205 leases and related subleases that the A&P debtors proposed to assume.

  • The decision to assume the leases was based on a “lengthy and thorough process.”
  • Both the creditors’ committee and the lenders supported assumption of the lease.
  • The A&P store across the street remained in operation, so control of the leased store continued to have strategic
    significance in blocking competitors from using the location.
  • The landlord offered buy out the tenant’s interest under the lease for $1.25 million.
  • The pre-petition monetary default for this lease that was to be cured within 10 days of the assumption order was only $42,300.37.
  • The A&P companies had an $800 million post-petition financing and over $300 million in cash and cash equivalent investments.

Based on these facts, both the bankruptcy court and the district court concluded that it was an appropriate exercise of the debtor’s business judgment to assume the lease, and that the debtor provided sufficient assurance of its ability to cure defaults and future performance under the lease.

The landlord also argued that this was a shopping center lease, meaning that it should be subject to Section 365(b)(3) of the Bankruptcy Code, which imposes additional requirements.  Namely that the debtor is required to provide adequate assurance:

  • of the source of rent and other consideration due under the lease;
  • that percentage rent will not decline substantially;
  • that assumption is subject to all the provisions, including radius, location, use or exclusivity provisions, and will not breach any such provision contained in the other lease, financing agreement, or master agreement relating to the shopping center; and
  • that assumption will not disrupt any tenant mix or balance in the shopping center.

Both the bankruptcy court and district court concluded that if these additional requirements were applicable (which they did not decide), the only relevant item was the first one regarding the source of rent and other consideration due under the lease.  (The bankruptcy court concluded that the other factors were not relevant, which the district court interpreted as a finding that there was adequate assurance for the other factors).  This conclusion appears to be premised in large part on the fact that the store had gone dark prior to the bankruptcy.  Thus, for example, any damage to tenant mix had already been done and would not be as a result of the lease assumption.

The landlord clearly did not want to be left with a closed anchor store, and apparently had other potential tenants who were willing to pay more rent.  However, the district court emphasized that Section 365 does not provide relief to a landlord “simply  because it might have the opportunity to rent the premises to others … at a higher rent and would otherwise seek to escape the bargain that it made.”

It is interesting to speculate whether the decisions would have been different if the store had gone dark after the bankruptcy was filed, or alternatively if the store was still operating at the time that the lease was assumed but the debtor expressed an intention to close at some time in the future.

It could be more difficult to conclude that the shopping center factors (such as assurance there is no adverse impact on the tenant mix or no reduction in percentage rent) are met.  However, if a tenant has a right to close under the lease, it can be argued that denying its right to assume the lease because it went dark post-petition or intended to do so at some time in the future could result in a windfall to the landlord:  If the tenant has a right to tie up a location by simply paying the rent required under the lease, its decision to go dark should not entitle the landlord to avoid the deal it struck with the tenant in favor of leasing the premises for higher rent to a new tenant willing to operate the store.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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