One of New York City’s iconic local retailers filed for Chapter 11 in mid-March, but it wasn’t until a couple of weeks ago that the company, Modell’s Sporting Goods, made an unusual request to the bankruptcy judge. The family-run athletic gear retailer that had shuttered 134 of its stores asked for a suspension of the proceedings as the coronavirus spread around the country.
The judge agreed to hit pause on the case. That means Modell’s landlords will not be able to receive rent payments on those stores, payments they would be entitled to during a bankruptcy proceeding.
The ruling has already proved a turning point for retail bankruptcy proceedings, experts said. It has helped other retailers now in Chapter 11 and struggling to restructure their companies with no stores in operation. But the decision has also further strained landlords who are unable to find replacement tenants amid the global pandemic and who are facing their own financial uncertainties.
“There’s just not this big supply of retailers waiting in the wings to backfill an old anchor and some of these big spaces,” said Soozan Baxter, a landlord consultant who has worked on the leasing of developments like Hudson Yards and Brookfield Place in Manhattan.
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The pandemic and statewide stay-at-home orders stopped Modell’s bankruptcy process in its tracks. Because it shuttered all its stores, Modell’s was forced to forgo crucial liquidation sales, said Michael Sirota, co-managing shareholder of law firm Cole Schotz, which is representing the retailer.
“It’s a little bit, in my view, inconsistent to say from a landlord’s perspective, ‘You owe us rent even though you don’t have access to our space,’” Sirota said.
But Modell’s landlords objected to the move, insisting that it allows Modell’s to stay in its space rent-free.
One group of those landlords, which included mall owner Macerich, who did not reply to a request for comment, said they “have no choice but to continue to allow the debtors to utilize their premises regardless of the risk of potentially never receiving payment for those services, and potentially without having any recourse.”
The Pier 1 case
Pier 1 Imports, which filed for Chapter 11 in February, cited the Modell’s ruling and asked for a variety of forms of relief because of Covid-19. Those included halting payments to landlords and vendors. Landlords also objected to those requests, but the court sided with Pier 1, which is now only required to pay “essential” expenses, like benefits for workers.
“While this reality has pushed healthy companies to the brink, companies that were already struggling for survival are now even closer to the edge,” Pier 1 said in its filing. “The challenge is especially acute for retailers in chapter 11 because actions that most retailers are taking out of court — not paying rent and stretching payments — are subject to the elevated priority of the Bankruptcy Code.” (An attorney representing the company in bankruptcy court, Joshua Sussberg, did not return a request for comment.)
Once a retailer files for bankruptcy, it still has to pay “administrative expenses,” which include rent going forward, even though it is not obligated to pay rent for the time prior to the filing.
And while a vendor can choose to not ship goods if a debtor doesn’t pay up, it is harder for landlords to kick out a tenant, especially if there is no one else available to fill a space, said bankruptcy attorney Pat Collins, a partner at Farrell Fritz.
“These ‘mothball’ orders are allowing companies to even limit their new expenses for a period of time,” he said. “But there are still expenses that a company needs to make even at this low level of activity.”
The requests for rent relief from bankrupt retailers — while perhaps understandable given the unprecedented scale of the pandemic — could have a ripple effect on landlords, many of which are already negotiating with tenants who are struggling to stay in their spaces without having filed for bankruptcy.
“The landlords are not receiving rents from tenants in many cases and … they have to pay off their lenders,” said Brett Miller, a bankruptcy attorney at Morrison & Foerster, and managing partner at its New York office. “So at what point are we going to see the mall REITs being on the verge of bankruptcy?”
The Forever 21 case
Meanwhile, in an unusual twist, one landlord group has had to seek relief for one of its bankrupt tenants, Forever 21, which it acquired in February. A joint venture with mall owner Simon Property Group, the buyer group asked a judge to ensure that its shuttered stores would not be considered abandoned; it also still needs the stores for going-out-of-business sales.
But some of Forever 21’s other landlords were not having it, arguing in court records that the request is not grounded in law and that Covid-19 has harmed them, too.
One landlord, in a court filing, said Forever 21 has not paid its February and March rent, and the landlord continues to incur obligations of its own, from mortgage payments to taxes to insurance.
“While sympathetic to the current conditions that all parties are facing due to the Covid-19 pandemic, the landlord is not relieved of its own obligations for the premises and the ‘free storage’ and nonpayment of the rental obligations by the debtors and/or the buyer should not be allowed,” said the landlord of a Forever 21 store in Phoenix.
Brookfield Asset Management, which joined Simon and Authentic Brands Group in the acquisition of Forever 21, declined to comment, and a Simon spokesperson did not return a request for comment.
There may be more retail rent battles in bankruptcy court on the way, as industry experts note that other companies, particularly aging department stores, could also be forced into bankruptcy because of the pandemic. JCPenney, for instance, recently skipped a key interest payment on a loan, paving the way for a default. And luxury department store Neiman Marcus is set to file for bankruptcy as soon as this week.
Prolonged store closures could also make it more complicated for some companies to file restructuring Chapter 11 cases amid the pandemic, knowing that retailers cannot generate revenue from those shutdown locations, said Cole Schotz’s Michael Sirota.
One major retailer that has filed a restructuring case so far has been designer jeans company True Religion. The retailer filed for Chapter 11 last week and was able to immediately secure debtor-in-possession financing to maintain operations.
True Religion, which has about 87 stores, said in its initial filings that without approval of that financing, it would not have enough money to cover the costs of a Chapter 11 case because of mandated store closures.
And even if a retailer files for bankruptcy in the future with the intent of emerging, it is likely the pandemic — and the uncertain timeline when stores and the economy will fully reopen — could dash those plans.
“It’s possible that companies may not be able to even pull off this on-life-support state of play,” Collins said.
As for Modell’s, Sirota said it is working with creditors and some landlords to hit the ground running once stores open again. But there are lingering questions about what retail will look like in a post-pandemic world.
“Are you going to go in at a time when unemployment is at an all-time high?” Sirota said. He added, “the truth is, nobody knows.”
Write to Mary Diduch at md@therealdeal.com