Toys R Us Ch. 11 Landlord Deal Could Be Model for Retailers

In a grand bargain covering some attorney fees for its commercial landlords, Toys R Us Inc. bought more time to decide which store leases it wants to reject in bankruptcy, creating what some experts say could be a practical template for other large retailers abruptly forced into filing for Chapter 11.
 
During the same week that Toys R Us unveiled plans to close about 180 stores nationwide by the end of April, the bankrupt retail giant also received more leg room to evaluate shuttering hundreds of other store locations.
 
Under an atypical deal approved by a Virginia bankruptcy judge last week, Toys R Us will allocate $1.3 million to pay the attorney fees and prepetition “additional rent” claims of its landlords, and will also waive any potential preference claims against those same property owners. In return, the company gets the freedom to use much of 2018 to decide the fate of several hundred U.S. store leases and shape what its physical footprint will look like post-bankruptcy.
 
Without the consent of store owners, the toy seller would have had to determine which of its remaining leases it wants to assume or reject by mid-April to avoid violating bankruptcy code rules.
 
It’s not unusual for insolvent retailers to negotiate with landlords in Chapter 11, but the deal Toys R Us concocted to secure more time to evaluate its extensive lease holdings provides novel consideration to store owners whose leases ultimately get rejected, some practitioners pointed out. The arrangement, which was approved over an objection raised by the U.S. Trustee's office, could serve as a model for other retail businesses that enter bankruptcy without restructuring plans already in place, some say.
 
“This is a pretty facile solution to their problem, which I believe is very real,” said Haynes and Boone LLP attorney Robert Albergotti. “It’s a fresh and innovative approach to dealing with a very large number of locations.”
 
The New Jersey-based children’s toy chain and owner of Babies R Us, which filed for bankruptcy in September with more than $5 billion in funded debt, negotiated the landlord consent package after choosing to keep all of its stores open during the 2017 holiday shopping season. With roughly 880 nationwide, determining which locations will positively contribute to an enterprise turnaround and which ones won’t as online shopping grows is no small task.
 
Just over a dozen years ago, bankrupt retailers were allowed to push off lease determinations indefinitely, allowing some debtors to slog through multiple Black Fridays and holiday shopping seasons before finally deciding which leases to keep and which to terminate. This changed in 2005 when Congress created a 210-day deadline for Chapter 11 debtors to assume or reject commercial real property leases.
 
It might be more time than needed for distressed merchants with only a handful of storefronts, but the time constraint can be problematic for larger businesses. In fact, nationwide retail giants that recently reorganized in Chapter 11, including Payless ShoeSource Inc. and Gymboree Corp., often had restructuring and store closure plans mapped out before filing for bankruptcy.
 
Toys R Us did not.
 
“This case was in total free fall when it was filed last year,” Venable LLP attorney Keith Owens said, noting that the company spent the first few months in bankruptcy focusing on paying suppliers and keeping its shelves stocked for the 2017 holiday season.
 
With time running out after the holidays to engineer a going-forward plan before the 210-day deadline, Toys R Us worked the only option it had to extend the time period: it garnered the written consent of landlords whose lease agreements were still up in the air by offering them an incentive to sit tight.
 
While it isn’t unusual for a debtor to pay its landlords’ attorney’s fees when it assumes the lease contract in a restructuring, “the issue of landlord’s attorney’s fees being paid as for rejected leases is a new concept,” Polsinelli PC attorney Christopher Ward said, calling the trade-off a “tremendous benefit” to both the debtor and landlord.
 
Bradley Arant Boult Cummings LLP partner Bill Norton, who represents a landlord in the case, said he was surprised to see some of the language in the company’s time consent offer but believes it was a well-devised way of getting store owners to cooperate and make it difficult for a judge to second guess.
 
“They nipped it in the bud, in essence,” he said.
 
By framing the payment for prepetition claims and attorneys’ fees as the fair exercise of a debtor’s business judgment, Toys R Us successfully argued that securing additional time to conclude its real estate analysis without making premature assumption or rejection decisions “far outweighs the value of any consideration” it would be giving to the landlords.
 
It’s not entirely certain whether the tactic employed by the company in its negotiations with landlord creditors will be replicated by retail debtors in future cases, but bankruptcy lawyers agree that this could serve as a model for other large merchants that hit Chapter 11 without a prepackaged bankruptcy plan.
 
“It’s spectacular from a logistical standpoint to do so with so many landlords,” said Jerry Bregman of Brutzkus Gubner Rozansky Seror Weber LLP. “This will be done whenever there’s a need and an ability to do it.”
 
With other large retailers teetering on the brink of insolvency, the chances only become higher that debtors’ attorneys may look to orchestrate similar incentives for landlords in the future.
 
Ira Herman of Blank Rome LLP, who called the deal a win-win for both sides, explained that the marketplace reality at this time also makes the trade-off more appealing for landlords since the demand for large retail spaces is in decline and new tenants are becoming difficult to find.
 
“It’s a template that makes sense in other cases,” he said. “It’s likely that landlords will be looking for similar types of deals.”
 
To the extent that bankruptcy courts approve similar measures that alter a debtors’ pool of creditor cash before a plan is confirmed, experts say that judges will likely take a fact-intensive look at the circumstances and consider whether stakeholders are on board.
 
Venable’s Owens said only time will tell what types of relief courts approve and what types of evidence will be needed to show a trade-off is in the best interest of a bankrupt estate, but it’s likely the Toys R Us case will be cited in the future, “now that there’s precedent for it.”
 
Toys R Us is represented by Edward O. Sassower, Joshua A. Sussberg, James H.M. Sprayregen, Anup Sathy, Chad J. Husnick, Robert A. Britton and Emily E. Geier of Kirkland & Ellis LLP and Michael A. Condyles, Peter J. Barrett and Jeremy S. Williams of Kutak Rock LLP.
 
The case is In re: Toys R Us Inc. et al., case number 3:17-bk-34665, in the U.S. Bankruptcy Court for the Eastern District of Virginia.

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