Prior to filing its bankruptcy reorganization proceedings on July 12, 2009, Bashas’ announced its intention to close unprofitable stores.  Bashas’ now has followed through and requested bankruptcy court authorization to reject fifteen store leases.  Bashas’ election to reject these unexpired leases, coupled with the extent to which it rejects additional store leases, serves as a forward indicator on the direction of its reorganization and the extent of recovery by the unsecured trade creditors.

The Impact of Lease Rejections on Unsecured Creditors

Bashas’ has requested bankruptcy court authority to reject leases for stores known or numbered as 1, 20, 32, 34, 38, 57, 59, 72, 84, 125, 146, 147, 602, 7th Street and the “San Luis” store.  Although suppliers and other trade creditors often are unconcerned by lease rejections, these creditors, next to the landlord itself, are the most adversely impacted by the rejection.  Here’s how it works:

Retail tenants in bankruptcy are given an option to assume or reject any unexpired lease for commercial real property.  The bankruptcy code gives a bankrupt tenant a “heads I win, tails you lose” arrangement under which the debtor can rid itself of leases that are undesirable and keep those with terms it considers to be favorable.

What many supplier and other unsecured creditors fail to understand is that when a lease is rejected, the affected landlord becomes entitled to a damage claim for breach of the lease on account of the rejection.  The damage claim, although subject to a formula that caps the claim, can be sizeable.  This damage claim is treated as a claim of a general unsecured creditor.

Although monthly rent is an administrative expense that has priority over unsecured claims, the damages from rejection of a lease may far exceed the rent that would have been paid during the pendency of the bankruptcy.  For this reason, lease rejections can have a substantial dilutive effect on unsecured creditor distributions.

For Suppliers the Flip Side of Commercial Lease Rejection

It stands to reason that a landlord, faced with the prospect of having an empty store and only a general unsecured claim to show for it, might be willing to renegotiate the lease.  Nothing increases a landlord’s willingness to reduce rents more than seeing other leases rejected.

Successful renegotiations would bode well for suppliers for two reasons:

• first, the number of profitable stores can be seen as directly proportional to the sales volume of suppliers’ goods through those stores; and
• second, if rents under leases that are not rejected can be renegotiated and substantially reduced, the adverse impact of the damages from lease rejections can be offset and the amount of distributions to be made to the holders of allowed general unsecured claims actually can be increased.

For Suppliers the Lease Rejection Analysis does not Stop with Impact on Distributions

It’s safe to say that all of Bashas’ leases are being scrutinized by the parties in interest.  It’s reasonable to expect that many of them will be renegotiated on terms favorable to Bashas’. However, lease terms, standing alone, may not be conclusive on Bashas’ decisions on store closings.  Other factors, including the presence or absence of nearby competitors’ facilities certainly play an important role.

Bashas’ will make the decisions on what leases to terminate based on its perceived self-interest.  The impact of lease rejections on suppliers’ pre-petition claim distributions is not a factor for Bashas’.  However, suppliers must understand the impact of commercial lease rejections on their interests as unsecured creditors and act and react accordingly.

Finally, we are well aware that, for many suppliers, the future prospects of an important customer are of greater importance than the extent of recovery of prepetition claims.  If the number of lease rejections should increase significantly above the fifteen already the subject of motions to reject, suppliers can take that as an indication the reorganization is falling short of its potential.  For a grocery store chain, size matters. Being too thin is not a good thing.