Increased Rent Provision as an Anti-Assignment Clause

Background

Section 365(f) of the Bankruptcy Code allows the assignment of leases and executory contracts notwithstanding any provision in the contract or the applicable law that “prohibits, restricts, or conditions the assignment….” So, explicit anti-assignment clauses are not enforceable when a trustee or a chapter 11 debtor seeks to assign the contract or leases. But what is the fate of clauses that are not explicitly anti-assignment?

Toys “R” Us

The issue was addressed recently in one of the Toys “R” Us leases. The lease was for the original period of 15 years and the tenant was allowed five four-year extensions. For the last four extension periods, however, the lease provided that if during these periods, the tenant and its affiliates are not the physical occupants of at least 80% of the leased space, the fixed rent payable shall be increased by a formula set forth in the lease. The court found that the formula results in an increase of the monthly rent from $23,265 to $33,000, or roughly 40%.

The debtors sought to assume and assign the lease while invalidating the rent increase provision as an anti-assignment clause. The landlord objected and the bankruptcy court agreed with the debtors, finding the rent increase provision to be unenforceable anti-assignment clause. The landlord appealed.

The district court affirmed holding that anti-assignment clauses are not only those that expressly limit assignments, but also those that due to their restrictive scope are effectively anti-assignment provisions: “[C]ourts look beyond the literal wording of a contractual provision to see whether it operates as a de facto anti-assignment clause in violation of § 365(f).”

Considering the rent increase at issue, the district court concluded that the provision was unenforceable “because [it] restricted the ability to assign the lease,” relying on the 40% increase in monthly rent. The district court also stated that because the increased rent could bar the assignment of the lease and the payment of increased rent could hamper the debtor’s reorganization, the rent increase clause may not be enforced.

Implications

As the prognosis for the retail industry goes from bad to worse with the emergence of the unanticipated threat of COVID-19 coronavirus, retail defaults could increase and creative attempts to utilize leased spaces may abound. This would result in significant attempts to obtain relief from burdensome lease terms. An increased reliance by debtors on the Bankruptcy Code provision annulling express and implied anti assignment clauses is likely. Unfortunately, however, the test distinguishing between an anti-assignment clause and pre-negotiated economic terms of the lease, even though unfavorable to the lessee and the assignee, is not well developed.

The case, 18601 Alderwood Mall Pkwy LLC v. Propco I Debtors, Case No. 3:19cv408 (D. Va. March 4, 2020), is available here: Read the opinion>>