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In re Toys “R” Us Property Co. I, LLC (Bankr. E.D. Va.) – Adjacent Retail Properties Do Not Constitute “Shopping Center” Despite Common Ownership, and Bankrupt Tenant May Assign Lease to Neighboring Tenant’s Competitor

The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

A bankruptcy court in Virginia has held that two adjacent retail parcels did not constitute a “shopping center” despite their common ownership; thus, a bankrupt tenant could assign its lease to a neighboring tenant’s competitor, in violation of the existing tenant’s exclusivity clause.  [In re Toys “R” Us Property Co. I, LLC, 2019 Westlaw 1075434 (Bankr. E.D. Va.).]

Facts: A landlord executed a long-term lease in favor of a toy store.  The toy store lease contained no use restrictions and it was freely assignable by the tenant.  A neighboring parcel, owned by a different landlord, was leased to a discount grocer.  The grocery store lease contained an exclusivity clause, and the landlord agreed that there would be no other leases to discount grocers.  Even though the two parcels were owned by separate entities, they shared some common parking areas.  Eventually, the owner of the grocery store parcel purchased the adjacent toy store parcel, thus bringing them under common ownership.

Some years later, the toy store filed a Chapter 11 petition.  During the bankruptcy proceedings, the toy store proposed to assign its lease to another discount grocer.  The landlord and the existing grocery store objected on the ground that under 11 U.S.C. § 365(b)(3), the debtor could not assign property within a “shopping center” in derogation of the exclusivity clauses contained in the existing lease; further, the proposed assignment would upset the existing tenant mix within the center.

Reasoning: The court overruled the objections, holding that the adjacent stores did not constitute a “shopping center” for purposes of the Bankruptcy Code.  The court acknowledged that there were some factors indicating that the properties did constitute a shopping center:

[T]here is a combination of leases, the leases are held by a common landlord, the tenants are engaged in the commercial retail distribution of goods, there is a common parking area and access road, and the stores are contiguous.

But the court then observed that many of those factors were present prior to the time that the landlord acquired both parcels, bringing them under common ownership.  The court held that there was no evidence that the landlord had purposefully developed a shopping center:

Elements that might indicate a purposeful development are a master lease, fixed hours during which all stores are required to operate, joint advertising, or the presence of an anchor tenant whose departure would give the other tenants the right to terminate their leases.

Author’s Comment: As a result of this decision, the landlord will be saddled with two discount groceries, right next door to each other: a disaster for both of them.  Given the facts of this case, I do not see what the landlord could have done to avoid the problem.  Often, however, leases come up for renewal or modification; those occasions are opportunities to update the documents to include provisions establishing the existence of a true shopping center.  Especially given the distress of “bricks and mortar” properties following the advent of online shopping, retail landlords must draft their leases with an eye toward tenant bankruptcies.

For discussions of cases dealing with related issues, see:

  • 2018-31 Comm. Fin. News. NL 6, Even Though Assignment of Shopping Center Lease by Chapter 11 Debtor Would Violate Use Clauses Contained in Other Leases, Assignment Is Permitted Because Debtor’s Lease Did Not Require Compliance with Restrictions in Other Leases.
  • 2004 Comm. Fin. News. 84, Existing Tenant in Shopping Center May Enforce Deed Restrictions to Block Chapter 11 Debtor’s Assignee from Operating Competing Supermarket.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw.  Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them. 

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