Real Estate Journal — Spring Preview —April 26 - May 9, 2019 — 5C

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By Thomas Onder, Esq., Stark & Stark Leasing tools to protect payments from an impending tenant in bankruptcy


a large unpaid arrearage, there are tools that landlords can use to mitigate this risk. The appropriateness of these tools should be addressed on a case- by-case basis when negotiating the lease. If you are a landlord in a bankruptcy case, it is impor- tant to know your rights now. Stark & Stark’s Shopping Center and Retail Develop- ment Group can help. Our bankruptcy attorneys regularly represent landlords through- out the country, including re- cently in the Eastern District of Virginia, District of Nebraska, continued on page 18C

olatility continues in the retail real estate env i ronment wi th

tion 541, all legal and equitable interest in the debtor becomes property of the bankruptcy estate upon the debtor’s fil- ing. This expansive definition means that once the debtor’s petition is filed, the security deposit is property of the bank- ruptcy estate. If a landlord applies the security deposit, even without knowledge of the bankruptcy case (as it would have prior to the bankruptcy on a default), then landlord will commit a violation of the Bankruptcy Code’s Automatic Stay and could subject itself to sanctions by the Court. Letter of Credit

The value of a letter of credit is that it is a promise by an issuer (the bank), to pay the landlord, as beneficiary, when the tenant defaults. The credit of the bank is substituted for the credit of the tenant. As such, a draw on a properly drafted letter of credit does not violate the Bankruptcy Code’s Automatic Stay, as it is not an action against the debtor and/or its property. However, there are risks, such as the “Payment Paradox.” In the Payment Paradox, a debtor be- comes delinquent. The creditor prepares to draw on the letter. However, before drawing, the

debtor sends the creditor full payment of the delinquent ac- count. Eighty-nine days later (within the 90-day bankruptcy preference period), the debtor files a bankruptcy petition. This acceptance of the funds from the debtor, rather than drawing on the letter of credit creates what is called a “pref- erential payment” than can be challenged by the debtor and/or trustee more than a year later, costing the landlord legal fees to defend the action, as well as possibly loss of the paid funds. Although there is no one solution to ensuring a tenant does not leave it’s landlord with

many tradi- tional retail- ers using the bankruptcy p r o c e s s t o r e o r g an i z e to right size themse l ves or in some cases leave

Thomas Onder

the market all together. When space is returned to a landlord it can present opportunities to reinvigorate a shopping center with fresh concepts that are trending up. However, the bankruptcy tenant may leave the landlord with an arrear- age for both the pre- and post- bankruptcy amounts owed that it may only see recoupment in pennies on the dollar, at best, years from the filing. Many landlords ask themselves, af- ter the fact, is there anything that can be done to mitigate this risk? Unfortunately, landlords cannot stop a tenant from filing for bankruptcy protection. But there are a few tools that a sav- vy landlord can implement dur- ing the lease negotiations that could manage and/or lessen the risk of a large arrearage. These include: third-party guaran- ties; larger security deposits; and/or letters of credit. There are pros and cons to each of these mitigation tools, but it is valuable to ascertain if one or all can be used on a particular deal. Guaranties A third party guaranty pro- vides the landlord with comfort of the tenant’s principals, par- ent and/or other associated entities having some “skin in the game.” Depending onwhom the guarantee is from will dic- tate whether the landlord can pursue the guarantee for pay- ment. Under Bankruptcy Code section 362 (the “Automatic Stay”), creditors are barred from proceeding with collecting debts from a debtor. However, as long as the guarantee is not with the debtor in bankruptcy, or the guarantor is not in bank- ruptcy itself, the landlord may pursue collection of the debt against the guarantor for the debtor’s non-payment. Security Deposits Requesting a larger security deposit is another form of pro- tection for landlords. However, the issue with a security depos- it centers on whose property it is. Under Bankruptcy Code sec-

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www.Stark-Stark.com tonder@stark-stark.com • 609.219.7458 • 993 Lenox Dr., Lawrenceville, NJ 08648

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