On February 2, 2015, the New York Stock Exchange took steps to delist RadioShack Corp., after suspending trading of its shares. RadioShack disclosed that one of its lenders, Salus Capital Partners LLC, claimed—for the second time—that RadioShack was in default of a $250 million term loan facility. That same day, The Wall Street Journal reported that RadioShack’s bankruptcy was imminent, and that the company would likely seek to sell substantially all of its assets at a bankruptcy court-supervised auction.
For RadioShack’s landlords, a bankruptcy filing poses unique challenges not necessarily faced by other creditors. For example, the rights that the Bankruptcy Code grants to debtor-lessees (such as RadioShack) are much greater than the rights RadioShack would have under state law under its leases. This memorandum will touch on some of these issues.
Leases of Non-Residential Real Property under the Bankruptcy Code:
The Bankruptcy Code treats RadioShack’s leases as “executory contracts” that may be “assumed” or “rejected.” By assuming a lease, RadioShack would have to accept all obligations under the lease. Also, by assuming a lease, RadioShack would be required to cure defaults under the lease, including past payment defaults. By contrast, if RadioShack successfully rejects a lease, the lease is breached and terminated.
RadioShack will have to make a decision whether to assume or reject its non-residential real property leases within 120 days after the Petition Date, or the leases will be deemed rejected, subject to one discretionary extension of an additional 90 days. Thereafter, landlords would have to consent to any extension of RadioShack’s time to assume or reject a lease.
Protections Afforded Landlords under the Bankruptcy Code:
While landlords’ rights are generally (and significantly) curtailed by the Bankruptcy Code, one protection the Bankruptcy Code gives to RadioShack’s landlords is that RadioShack must pay rent after it files for bankruptcy. Specifically, Bankruptcy Code § 365(d)(3) requires RadioShack to pay the full contract rent/obligations when due until the bankruptcy court enters an order approving the rejection of the lease.
The date of rejection is an issue because that is the date that typically determines the end of the period where post-bankruptcy rent must be paid in full. Also, the condition of the premises may be a factor affecting landlords’ claims. The Bankruptcy Code also caps rejection damages claims related to commercial real property leases. It is important for landlords to consult with counsel when filing and/or negotiating lease rejection claims to insure that landlords receive the full benefit of the statutory maximum claim provided under the Bankruptcy Code.
The timing of RadioShack’s bankruptcy and where it files for bankruptcy are critical. This is because bankruptcy courts differ as to RadioShack’s obligation under § 365(d)(3) for RadioShack to pay rent for the post-bankruptcy portion of the initial month of its bankruptcy case—often termed “stub rent.”
Landlord’s Rights Related to Assignment of Leases:
In addition, RadioShack may attempt to assume and assign its leases to third parties. In this instance, leases may be assigned notwithstanding non-assignment clauses. But the Bankruptcy Code gives four protections to shopping center landlords against potentially having to accept an unfavorable tenant as a result of an assigned lease.
- First, to replace the original tenant, the new tenant must be at least as financially sound as the original tenant was at the time the lease was originally signed.
- Second, the new tenant must show that percentage rent will not decline substantially.
- Third, the assignment may not disrupt the tenant mix.
- Lastly, the assignment may not violate any location, use, radius or exclusivity provision of the lease, or of any other leases, at the shopping center.
Issues Regarding a Sale/Restructuring:
As mentioned in the Wall Street Journal article, RadioShack is may attempt to sell substantially all its assets at auction. This creates a host of issues for landlords, generally regarding the assignment of shopping center leases. Generally, in connection with such a sale, RadioShack will attempt to assume and assign many of its leases to the purchaser. Landlords need to pay attention to the proposed assignee and object to the sale if the purchaser/assignee is unacceptable as a replacement tenant or if the terms of the adequate assurance are insufficient.
In addition, RadioShack, in connection with the rejection of leases, may propose uniform “store-closing procedures” and GOB sales that could be disruptive. Landlords should scrutinize any such proposed procedures before they are approved by the bankruptcy court to ensure that store-closing procedures do not violate applicable leases and disrupt other tenants’ businesses at each affected shopping center.
Issues with RadioShack’s Lenders:
Prior to its bankruptcy, RadioShack will likely have negotiated with one or more of its lenders to provide the financing needed to see it through its bankruptcy, which is known as debtor-in-possession or “DIP” financing. RadioShack’s DIP lenders will likely place onerous liens on all of RadioShack’s assets—including RadioShack’s leases for non-residential real property. RadioShack’s landlords will need to scrutinize any order permitting DIP financing to make sure, among other things, that landlords will not lose their ability to setoff mutual amounts the parties owe to each other (such as the right to setoff outstanding pre-bankruptcy rent against security deposits). In addition, landlords will need to be comfortable that the DIP lenders will permit sufficient cash to be used to pay post-bankruptcy rent.
Landlords Must Act Early to Protect Themselves:
The best protection for RadioShack landlords against the hassles of dealing with RadioShack during its bankruptcy is acting early and avoiding being on the defense. For example, landlords should consider setting off pre-bankruptcy unpaid rent against security deposits (to the extent allowed under the leases), as any such post-bankruptcy setoff may require bankruptcy court approval. Security deposits are best applied to the prepetition claims.
Further, bankruptcy law provides that a lease that has either expired by its terms or was properly terminated prior to the bankruptcy cannot be assumed or rejected, with the lessee whose lease has been properly terminated pre-petition having no further rights in that lease. Landlords accordingly should evaluate whether they have the ability to terminate a RadioShack lease before it files for bankruptcy. Once RadioShack files for bankruptcy, any attempt by landlords to terminate RadioShack leases is automatically stayed.
While these are just a few of this issues that landlords will face in a RadioShack bankruptcy, landlords should protect themselves by consulting legal counsel early. This can help ensure that landlords have the best chance to receive their rent and other payments due under RadioShack’s leases.
There may be an official or an informal ad hoc lessors’ committee appointed in the bankruptcy case to represent landlords’ interests. Such committees can be helpful in negotiating the terms of assumption/assignment or rejection of leases related procedures and may also help defray costs incurred for individual representations.
McKool Smith has offices in New York City and Dallas, Texas, and often appears in bankruptcy cases filed in Wilmington, Delaware. These are the likely locations for RadioShack’s bankruptcy filing.
If you have any questions or are looking for legal representation feel free to call either Peter Goodman at 212-402-9408 or Michael Carney at 212-402-9414.
Attorney Advertising Disclaimer. Prior results do not guarantee a similar outcome. This information is provided by McKool Smith for informational purposes only and is not intended, nor should it be construed, as legal advice.