If only for the sheer size of the chain’s presence in Canada, occupying about 15.4-million square feet of retail space, the giant retailer’s short life here, and its departure under the protection of the Companies’ Creditors Arrangement Act (CCAA), serves as something of a lesson for those negotiating and executing commercial leases. What happens to all the empty spaces it leaves behind and the effect its exit will have upon property owners and other tenants? And how do those original leases play into the current narrative?
Of the 133 Target stores in Canada, insolvency lawyer David Ullmann, who was involved in the final negotiations on behalf of a landlord with nine Target locations, estimates that landlords for 80 to 90 of the properties had taken guarantees from the U.S.-based Target Corp. Those without guarantees add their claim for unpaid rent or other damages to the list of unsecured creditors.
A large retailer with the ability to serve as an anchor tenant in a mall or retail complex can be desirable for landlords that may well make concessions not available to other businesses. In Target’s situation, its interest in taking over former Zellers locations across the country allowed the discount retailer to arrive to lease negotiations with a great deal more clout than the average tenant, resulting in the potential for the retailer to end up with enhanced control over the shopping centre.
Just the same, both the landlord and tenant need to ensure they have protected themselves against all eventualities. In the example of Target, key for landlords was getting the financial backing from the U.S. parent company to ensure any money owed would be paid. “It emphasizes the importance of not being mesmerized by a large U.S. company coming to Canada,” says Dennis Daoust, a commercial landlord and tenant law partner at Daoust Vukovich LLP. “In a lot of cases if [the shopping centres] were smart, they got a guarantee from the parent company.”
A major concern when a tenant leaves under bankruptcy or CCAA protection is what happens to the lease. “There’s value in the leases. The problem is, there’s not one big buyer out there,” says Daoust partner Wolfgang Kaufmann.
A complicating factor with Target selling its leases is the fit of the incoming tenant or tenants to the shopping centre. Any assignment of the lease needs to respect any existing covenants. But also other leases could be tied to Target’s. Target may have served as a magnet, attracting other stores to the shopping centre. Other retailers’ agreements to lease in the same centre might well hinge on Target’s presence there. The fear is the departure of one could result in the departure of others.
Among the few possibilities for multiple Target locations are Wal-Mart and Loblaws, as both chains continue to expand in the Canadian market. But a supermarket already existing in the centre may well have a restrictive clause, preventing other grocery stores from setting up shop in the same location. As a grocery chain, Loblaws could prove to be a conflict in such a scenario, as could Wal-Mart, which now has substantial food sections.
Landlords, fearing conflicts with other tenants, might well buy out the leases to maintain control. “The landlord is, in effect, negotiating for all the other stores,” says Daoust. One option is to subdivide the space to attract several different shops once occupied by Target.
That approach might actually be advantageous for the centres, says Michael Leroux, the leader of Richards Buell Sutton LLP’s commercial real estate group. “Those locations are sometimes beneficial to the landlord,” he says.
Often it all comes back to the original lease. In addition to ensuring the backing of the parent company where possible, Leroux suggests letters of credit be included and that there be sufficient security deposits and additional rents at the outset. Once a business is in trouble, it’s tough to recover any money. Negotiating a termination clause in the lease is also an option, although a landlord is more interested in a business planning for success, not one planning for possible demise.
If the relationship between the landlord and tenant is strong, there is always the possibility of negotiating terms to get out of the lease for a tenant that is having trouble paying the rent. “That means the tenant has to go cap in hand to the landlord,” says Leroux.
Much of the landlord’s stake lies in leasehold improvements conducted on the space for the tenant, adds Michael Kennedy a partner in the corporate/commercial group of Patterson Law’s Halifax office. Those expenses are typically built into the tenant’s rental payments. One option is for the landlord to separate the improvement costs from the rent by offering a loan instead. But that still leaves the landlord as an unsecured creditor in the event of insolvency.
Kennedy likens CCAA court-monitored proceedings as something close to receivership, leaving landlords — often the largest creditors — with limited remedies unless they’ve secured financial backing. “Most of the landlords would never have had a thought [Target would] go insolvent,” says Kennedy. “Unless you have monetary controls outside of the lease . . . there’s nothing you can do.”
If such a large company can end up insolvent, the lesson is that nothing is too big to fail. As such, much hinges upon initial and subsequent agreements. While the landlords will have wanted to protect themselves as best they could, much lies in their negotiating power and the degree of the landlord’s desire to nail down that anchor tenant. And while the lease can contain all kinds of provisions in respect to insolvency, both the CCAA and the Bankruptcy and Insolvency Act can override those provisions.
Target, like many other large businesses in Canada, chose to go the CCAA route instead of filing for bankruptcy. “This CCAA can, in fact, function like a poison pill,” says Daoust. He has seen a resurgence in the number of businesses preferring to restructure under the CCAA over the past decade and a half. “It’s almost as though what happened was a retail chain that was in trouble stumbled across the legislation,” he adds.
Although it originally grew out of the depression in 1933, CCAA saw something of a resurgence in the 1990s, observes insolvency lawyer David Ullman, a partner with Minden Gross LLP. Boutique Jacob, Mexx, Bowring, and XS Cargo all used the CCAA in connection with their recent insolvency proceedings.
The statute allows for creative approaches to problems that the more rigid bankruptcy regimen does not. But what has been more controversial, he points out, has been the recent trend towards using the CCAA in pure liquidation proceedings. The CCAA doesn’t have the same codified procedures and timelines required by the Bankruptcy and Insolvency Act and the relevant provisions of provincial commercial leasing statutes, giving greater flexibility which are seen as beneficial to the tenant and a detriment of the landlord.
The negotiations between the landlords and Target Canada concluded with a consent order, setting out an agreement on the sale of the leases under the supervision of a court-appointed monitor.
At issue was whether Target should be forced into bankruptcy instead of proceeding by way of CCAA because it was not seeking restructuring in the traditional sense, but rather pursuing pure liquidation. The parties ultimately settled on a deal which addressed both the concerns of the landlords that delays could leave unoccupied properties in limbo as well as Target Corp.’s goal of getting out of Canada on a schedule which it hopes will maximize recovery. “One of the key takeaways for landlords from this process in Target is to remember that they don’t always have to accept what the tenant in CCAA protection is offering them. Landlords can flex their collective might to have a more fair process put in place, over the tenant’s objections,” says Ullmann.
June 30 was set as the final deadline for the retailer’s sale of the leases. The rights for any leases not sold by then are returned to the landlords. As Target works toward its spring goals, eyes will be upon the assignment of the leases. Ullmann suggests the use clause in the leases could well play into what happens next. If the terms of the clause are too general, it will be easy for the tenant or trustee in bankruptcy to assign the lease to a new tenant. If it is too restrictive a court may strike it. Landlords don’t want to see either scenario. The key, says Ullmann, is balance.