The debtors sought court approval of the assumption and assignment of a shopping center lease. The landlord objected on the grounds that the assignment would not comply with exclusivity provisions in another tenant’s lease and would disrupt the tenant mix. Thus, it did not comply with the requirement that the debtors provide adequate assurance of future performance.
Under section 365 of the Bankruptcy Code a debtor may not assume a lease unless it provides adequate assurance of future performance. Section 365(b)(3) provides special requirements applicable to shopping center leases. Among other things, this section requires adequate assurance (emphasis added):
- that assumption or assignment of such lease is subject to all the provisions thereof, including (but not limited to) provisions such as a radius, location, use, or exclusivity provision, and will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to such shopping center; and
- that assumption or assignment of such lease will not disrupt any tenant mix or balance in such shopping center.
In this case the debtors auctioned off various assets including the shopping center lease in question. After the winning bidder withdrew its bid, the debtors proposed to assign the lease to the backup debtor – Burlington Coat Factory, which wanted to operate a department store for the sale of “off-price” apparel and other merchandise.
The lease for one of the other tenants (Ross) included a provision that without its consent “no tenant or occupant of the Shopping Center (other than Tenant) may use, and Landlord, if it has the capacity to do so, shalt not permit any other tenant or occupant of the Shopping Center to (a) use its premises for the Off Price Sale (as hereinafter defined) of apparel …”
The section of the Bankruptcy Code requiring compliance with provisions such as use or exclusivity was intended to protect the landlord’s interest rather than the interests of other tenants. The intent was to protect bargained-for protections spelled out in the debtor’s lease not give the landlord new rights.
The Ross lease was executed after the debtor’s lease. The court noted that some leases contain provisions that would prohibit assignment to an assignee whose use would conflict with exclusive use clauses in then-existing leases. However, the debtor’s lease did not include such a provision.
So, the court found that the debtor’s lease, which was executed long before the Ross lease, did not require compliance with the Ross lease use restrictions. Thus, the assignment would not violate any use or exclusivity provisions applicable to the debtors.
Alternatively, the court focused on the clause in the Ross lease stating that the prohibition on the landlord not permitting other off-price tenants applied “if it has the capacity to do so.” The court decided that court approval under section 365 meant that the landlord did not have the capacity to prevent Burlington’s use.
As for the tenant mix, the court noted that there were approximately 43 stores with only two other primarily “off-price” stores. The landlord did not show that adding a third off-price store would disturb the tenant mix.
Accordingly, the court found that the debtors met their burden of providing adequate assurance of future performance, so approved the assumption and assignment of the lease to Burlington.
Negotiating and enforcing prohibited use and exclusivity clauses can be tricky, particularly if there are pre-existing leases that do not give the landlord sufficient control over the original tenants.
Vicki R Harding, Esq.