As the COVID-19 situation continues to develop, the retail industry will face a number of complicated business and legal scenarios resulting from legislation enacted in response to the virus as well as precautions taken to stem its spread.
In particular, mall owners may be impacted as malls are ordered to close (or voluntarily do so) in order to avoid any large gatherings.
Mall owners will have to consider their employees, the public and their tenants. Lastly, mall owners should examine their own financial health and decide what to do in the current economic environment.
A. Major Legal Considerations:
1. Employee Concerns
Regardless of whether or not the malls stay open, mall owners will have to consider heightened cleaning regimes and other updates to their protocols in order to protect their employees. Even if a mall is closed, basic maintenance on the property will still have to be done. In addition, owners will want to maintain a security force while the premises are closed. Notably, some state governments have begun issuing executive orders and other recommendations for workplace hygiene. Mall owners should be sure to also consult local counsel on the state-law specific issues that may arise with respect to employee considerations.
Under the general duty clause of the Occupational Safety and Health Act (“OSHA”) employers must “furnish to each of his employees employment and a place of employment which are free from recognized hazards that are causing or are likely to cause death or serious physical harm to his employees. 29 U.S.C. § 654. Employers should continuously consult evolving OSHA guidance regarding COVID-19. Employers providing employees with protective equipment should ensure they also provide OSHA-compliant training.
As concerns potential worker claims, workers’ compensation programs provide benefits to eligible employees who suffer job-related injuries and illnesses. As a general rule, where the harm arises out of and in the course of employment, employees are limited to the prescribed workers’ compensation benefits and cannot recover damages for pain and suffering or mental anguish. Some states allow additional awards when injury results from an employer’s “willful” or “intentional” act.
Beyond these safety considerations, mall owners should consider how other government regulations may impact their business and their employees. For example, state and federal governments have issued regulations to address the issue of paid sick leave for employees impacted by COVID-19. Mall owners should consult counsel and consider how (if at all) they are impacted by these state and federal rules.
2. Liability to Public
Currently, many states and cities are ordering bars and restaurants to close with only limited exceptions. Malls attract similarly large crowds and, even if they are not already subject to executive orders, some malls are nonetheless considering closing their doors as well. Notably, many malls have already closed their doors and will remain closed until the end of the month. Other malls have limited their hours but have not yet closed completely.
Retail clients, in considering whether to stay open or to close, will consider, among other things, whether there is any potential liability to the public, their employees or others stemming from potential exposure to COVID-19. There is also reputational and public relations matters to consider as a result of any claims, or even news materials that implicate the mall as an alleged source of transmission.
On the merits, in considering the risk of such claims, ultimate liability may be difficult for any potential plaintiffs to prove. In particular, a business may satisfy its duty of reasonable care by providing an adequate warning of dangerous conditions. Additionally, plaintiffs seeking to bring torts claims in the context of the COVID-19 epidemic may find a number of hurdles, including: (i) difficulty establishing negligence where the pandemic and guidance regarding proper prophylactic measures evolves quickly; (ii) difficulty proving causation; and (iii) in the case of a cluster tied to a particular location, difficulty obtaining class certification.
3. Property Owners Meeting Expenses
Without rental income from retail tenants, owners will be unable to meet their obligations to pay operating expenses, taxes and debt service. Many states, including New York in connection with the just-passed NY PAUSE order, are placing moratoriums on evictions and foreclosures in the residential and commercial spheres. The sheer volume of pending defaults leads practitioners to believe that lenders will be forced, as a practical matter, to accommodate distressed borrowers and that lenders will be unlikely to call defaults and accelerate loans in the near term. However, clients are reporting an inability to reach lenders, particularly servicers and special servicers, who are overwhelmed by the number of anticipatory requests that have been made.
Borrowers should also consider asking lenders to apply reserves to pay expenses even if reserves were held for other purposes (e.g., TI and leasing reserves) in order to keep loans current and avoid lenders having to mark loans as non-performing. Some borrowers will look to accomplish short-sales or deeds in lieu. In such cases, make sure to review guarantee provisions to ensure that liability of guarantor is extinguished for any periods after a deed in lieu is granted.
Before speaking to lender, it is critical that the parties enter into a pre-negotiation agreement in connection with which lender and borrower agree that discussions are for settlement purposes only and cannot be used as evidence in any subsequent proceeding to avoid anything discussed as an admission of any sort.Note that certain loan agreements have events of default and non-recourse carveouts that are triggered by borrower’s ”admission of its inability to pay its debts as they come due.” This is a hair-trigger provision that could create a huge shift in leverage to lender if tripped.
B. Top Business Considerations:
1. Mall Closures and Potential Storeowner Issues
Mall owners may find themselves in a position where they want to close, but a specific tenant wants to keep its doors open. Alternatively, a mall owner may want to remain open but many of its store owners have decided to close.
Mall owners will have to review the relevant lease agreements to determine their obligations to individual storeowners and vice versa. In reviewing these documents consider: (i) what performance is required, including whether any provisions excuse a party’s performance on the basis of an event beyond that party’s control (i.e., a force majeure clause), (ii) whether course of performance has deviated from the terms of the agreement, (iii) going dark clauses and operating covenants, (iv) the governing law, (v) the parties’ expectations at the time of the agreement and (vi) any risk-allocating mechanisms in the contract. Any message to store owners should be drafted in consultation with counsel and after careful review of the relevant lease provisions.
2. Accommodations on Rent
Rent reductions and other accommodations may be made when tenants are struggling. Mall owners will have to determine their appetite for offering such accommodations where the economic issues are more widespread and systematic. Accommodations are taking a range of forms right now from waiver of late payment fees to short term rent forgiveness or deferral. Strategically, the long term viability of a tenant and its guarantor need be taken into account in fashioning proper tenant relief. If such accommodations are made, mall owners should consider what they will seek in exchange, possibly including a grant of additional protections such as a security interest, guaranty or amendments to the lease to tighten terms, including future escalations. However, any such amendment may be subject to challenge in a subsequent tenant bankruptcy.
It is also worth mentioning that industry advisors are exploring the possibility that business interruption or rental interruption insurance would cover lost rent. Absent contractual coverage for viral contamination, most policies do not appear to cover COVID-related losses. Some are exploring whether there are creative claims that can be made relating to forced governmental closure or contamination generally. Without a legislative fix requiring payment by insurance companies (perhaps with the backstop of government support to the insurance companies) on such claims, there is likely to be a pitched battle over these claims. Notably, the first case seeking coverage for COVID-related closure losses was filed in Louisiana this week.
3. Debt reduction/buybacks
Well-capitalized property owners may take the opportunity of market dislocation to repurchase some of their debt at a discount. Note that many loan agreements prohibit borrower and borrower affiliates from owning any of the debt. In addition, intercreditor agreements (which borrowers in the real estate financing context are not typically privy to) typically prohibit lenders from transferring debt to borrower or borrowers affiliates and if borrower or its affiliates do purchase such debt, they are likely to be deprived of voting and remedial rights. These limitations could lead to the strategy of buying and retiring such debt. Borrowers considering this possibility should be aware that there is the possibility of tax liability arising from the cancellation of indebtedness purchased at a discount. In addition, the underlying loan documents, including any intercreditor agreements, typically require loan repayments to be made in a certain order (sequential or pro rata) and this must be confirmed in connection with undertaking this strategy.
C. Top Bankruptcy-Related Issues:
1. Liquidity Issues
On the borrower side, liquidity concerns may mean that mall owners will consider drawing on their revolvers up to the remaining capacity. When drawing on revolvers, borrowers typically must confirm that no default or event of default has or will occur as a result of the borrowing. Borrowers also typically have to agree to bring down all representations and warranties in the credit agreement. Mall owners should also carefully review their credit agreements’ financial maintenance covenants and monitor their financial covenant levels to ensure continued access to loans under their facilities and avoid default, as well as consider whether a near-term draw will avoid difficult questions in the future. Notably, the definition of “EBITDA” in a credit agreement may include certain addbacks that can be utilized to limit any covenant impact (i.e., unusual, non-recurring or exception expenses, proceeds of business interruption insurance etc.).
On the lender side, lenders should undertake a similar review of the financial covenants and provisions discussed above. In addition, lenders should understand their collateral package and confirm that all liens are valid and duly perfected. Lenders should become familiar with all notice, cure and grace period requirements and understand any limits on individual lender actions. Prior to taking any action, including refusing a funding request or declaring an event of default, lenders should consider the impact of such action on potential make-whole premiums and/or exposure to breach of contract/lender liability claims.
2. Debtor-in-Possession Financing
Post-petition debtor-in-possession (“DIP”) financing is often provided by a debtor’s pre-petition secured lenders or equity holders and can provide unique protections and opportunities for such parties. For existing lenders, there is the opportunity to “roll-up” pre-petition debt into the DIP facility in many circumstances, and DIP lenders can gain meaningful control of the debtor’s chapter 11 cases, including through enhanced credit protections, negotiated DIP budget requirements, and establishment of key bankruptcy case milestones. Because DIP lending is also typically at the very top of the priority waterfall, it can provide a solid financial return in a relatively safe position.
3. Credit Bidding
A secured lender may consider purchasing a debtor’s assets in bankruptcy through “credit bidding,” which allows the secured lender to purchase its collateral partially or wholly through forgiveness of the secured debt. Parties also may consider buying secured claims against debtors in order to be able to credit bid or otherwise have a role in the proceeding. Particularly where lenders/funds have institutional sell-off requirements on downgrades or similar events, these claims can often be acquired at a significant discount.
4. Leases in Bankruptcy
A debtor may assume, assume and assign to a third party or reject its leases in bankruptcy. Assumption and assumption and assignment is subject to the debtor or assignee curing all defaults and providing adequate assurance of future performance. In the context of shopping malls (as defined under the Bankruptcy Code), the adequate assurance standard is significantly higher and tenants in malls or shopping centers, in particular, must show that assumption and assignment will not disrupt “tenant mix,” that any percentage rents will not decline substantially, and that the new assignee has the same credit quality as the tenant as of the time of the original lease. Where the debtor is the tenant, lease assumption must be completed within 120 days. The initial 120-day period may be extended for 90 days upon court order but, after this, the period cannot be extended without landlord consent. Leases not assumed by this deadline are deemed rejected. (Notably, this timeline does not apply to debtor-lessors – e.g., when the landlord-owner is the debtor).
As a result, mall owners have quite a bit of leverage that they may use to get out of an unfavorable lease (i.e., a lease that is significantly below market). Mall owners may wish to negotiate lease buy-outs, where the tenant agrees to be released from the lease and is paid a small amount, or lease amendments to make the terms more favorable. On the flip side, tenants with above-market rents may use the option to reject a lease as leverage of their own.
Mall owners are encouraged to engage early with tenants that may be at risk of entering bankruptcy in order to have the most influence over the potential outcome of its lease with the mall owner. As mentioned above, a tenant can also assume and assign its lease to a third party so long as the bankruptcy court determines the adequate assurance threshold is demonstrated, leaving the mall owner with a new tenant that may be problematic for the mall owner or neighboring mall tenants.
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