A few years ago, when the value of commercial real estate was much higher, Sacramento landlords signed many favorable leases. Now, with the change in the market, many Sacramento tenants are looking for rent concessions, a full blown lease modification, or an outright walk-away. Failing to obtain the relief demanded, tenants can file for bankruptcy protection to jettison unwanted leases or force demanded modifications on desperate landlords.
That is exactly the scheme used by one of Arizona’s most prominent real-estate firms, Realty Executives, Inc. Realty Executives filed for bankruptcy reorganization as a legal strategy to circumvent a handful of what this company termed as “uncooperative landlords.”
Realty Executives was unable to negotiate better terms for a handful of its 15 office leases. So, Realty Executives filed its Chapter 11 bankruptcy petition along with a request for immediate court approval to “reject,” or walk away from, four of its 15 lease agreements. In exchange for breaking the leases, Realty Executives proposed adding the amount still owed on each lease, not to exceed 12 months’ worth of payments, to the company’s list of unsecured debts to be settled in the bankruptcy. Faced with rental losses, several of Realty Executives’ landlords are renegotiating their lease deals. If the negotiations fail, Realty Executives still has time to add other leases to its list of rejects.
Unfortunately for California landlords, Realty Executives rejection request and proposal is fairly standard. Chapter 11 reorganization is commonly used by tenants to break burdensome lease agreements since the U.S. Bankruptcy Court generally gives debtors broad discretion to decide which lease agreements and other service contracts to reject or keep in a reorganization proceeding. Many well known national businesses are currently using the same strategy as Realty Executives in dealing with their leases. Dallas-based business, Blockbuster, filed for Chapter 11 Bankruptcy protection last year, rejecting about 220 leases for stores and is now adding another 185 to the rejection list. Another well recognized company, Borders, is using its Chapter 11 proceedings to streamline its lease modifications.
Is the Sacramento landlord without options to protect their interests? Not entirely. Protection first starts with the lease agreement, which should always be drafted with standard provisions to protect the landlord’s rights and offer favorable remedies in the event of a tenant default. Sacramento landlords should then perfect a contractual landlord’s lien as soon as the lease is signed. Next, Sacramento landlords should continually monitor a tenant’s financial condition and immediately consider a tenant’s request for a rent concession or lease modification. A landlord must move quickly to regain possession of the premises if a workout is not possible. Lastly, if the tenant ultimately files bankruptcy, file the necessary court documents to protect the landlord’s rights in the proceedings by regaining possession of the premises, claiming administrative rent, and/or filing a proof of claim.