Originally published in the Fall / Winter 2018 edition of CAIRP’s Rebuilding Success magazine.
The Canadian retail market (like its U.S. counterpart) has seen more than its share of spectacular failures in recent years. Sears Canada and Target Canada to name two such failures are emblematic of the sort of convulsive upheaval which has adversely affected suppliers, customers, and employees in the tens of thousands.
It is an interesting vantage point for a bystander to observe how one group of creditors has responded to these circumstances. Commercial landlords (if you ask them) will often describe themselves as the Rodney Dangerfield’s of the insolvency world. True or not, they and their counsel rise to the occasion in each and every instance to protect their interests. These they have articulated carefully over the years to a level where we could safely agree that anyone with a passing familiarity in retail restructuring will expect to hear from the landlords on a handful of key points. It is not the purpose of this discussion to dwell on the substance of these issues, rather it is to explore the landlords’ willingness to adopt lesser seen strategies and positions in this recent spate of retail insolvencies, and the impacts these have had on the restructuring process itself.
This article will discuss the landlords’ roles as “commercial players” and “official opposition” in complex retail insolvencies. Recent cases including Target Canada, Laura Shoppe, Rockport and Payless, demonstrate the creative and facilitative roles that landlords can take in CCAA restructurings.
The Commercial Player
On January 15, 2015, Target Canada and affiliates filed for protection under the Companies’ Creditors Arrangement Act and contemporaneously announced that it would be closing all 133 retail stores (there was a total of approximately 140 affected locations) it had opened since commencing operations less than two years previously in March of 2013. While “liquidating CCAAs” are common, this one was hotly contested from the outset by the landlords who felt their interests could best be protected in a bankruptcy process. Peace was arranged among the parties in the form of agreements and changes to the Initial Order recognizing that any guarantee claims relating to real property leases which any landlord may have against Target Canada’s U.S. parent, Target Corporation, would not be determined in the CCAA proceeding, nor released or affected by any plan filed by Target Canada or its affiliate applicants. More on this later.
Target Canada was seeking approval of the so-called Real Property Sales Process (RPSP) and had sought the affected landlords’ consent. The RPSP was fairly typical in structure involving a two phased process, with a month long initial bid solicitation commencing in early February seeking non-binding letters of intent from prospective acquirers, with a second phase lasting approximately 20 days to select a “stalking horse” bid from amongst the qualified bids received. From this point, there would be a further month to determine the universe of qualified bids, conduct auctions if circumstances warranted, and a targeted completion date of mid-May. The terms of RPSP contemplated time for due diligence, expense reimbursements, financial qualification of the bidder and the usual elements addressing closing risk to the seller. The terms of the RPSP were subsequently amended to accommodate bids from landlords as well as augmenting the diligence requirements on prospective bidders’ capacity to meet financial obligations under any lease(s) they might be bidding for, as well as an extension to the outside date to complete any sales.
As revealed by the monitor in its reporting to the Court, certain landlords had advised the company that they were interested in purchasing some of their own lease properties which were included in the RPSP portfolio. On February 6, those landlords submitted an “unsolicited,” non-binding letter of intent to that effect. Target was advised that the landlords wished to move quickly and required that a transaction be completed as soon as possible. By February 12, a second non-binding LOI had been concluded evidencing, among other things, the landlords’ intention to enter in the definitive binding agreements on an expedited basis, with no due diligence and with no external sources of financing. By February 26, the parties had entered into a binding definitive agreement which received court approval on March 5.
The monitor reported that the cash consideration paid for the acquisition of these lease properties was $138 million, subject to adjustments. While the RPSP included more typical transactions such as lease assignments, surrenders, and the like, this particular transaction by its terms and consideration stands out for its aggressiveness both in terms of the consideration of the bid but also the speed and expediency of its execution. In numerical terms, this transaction alone represented approximately 25 per cent of the cash recoveries from the portfolio. Remarkable.
It would come as no surprise that in most circumstances, a tenant such as Target would be a prime anchor for a shopping mall, and this is indeed the case. Landlords often refer in legal arguments to their artfully crafted store mix which enhances synergies for all tenants provided it is not tampered with through, among other avenues, the restructuring process. The CCAA debtor’s ability to compel the assignment of agreements is a disturbing eventuality to landlords who seek to maintain the integrity of the “store mix.”
We would argue that the Target case is an example of landlords aggressively removing that possibility by making an offer that couldn’t be refused. The burden taken on by the landlords should not be minimized. We understand that owing to nature and size of the properties, many remain untenanted and therefore represent a continuing cost burden in a variety of ways. However, in February of 2015, the prospect of burdening a prime project with an anchor tenant (however financially viable) that does not fit the “character” of the property was a prospect not to be countenanced. Whether such a deal would be available today is another matter, proving only that the landlords are prepared to use their financial clout and legal resources to protect their interests where the circumstances may call for a commercially aggressive solution.
The 2015 case of Laura Shoppe (Laura), as well as Nine West and Rockport, illustrate another trend in landlord interventions in the restructuring process. Laura Shoppe, a Montreal based retailer filed an NOI on July 31, 2015. Laura operated approximately 162 stores under the names Laura and Melanie Lyne across Canada, and employed approximately 2,300 employees at the time of filing. From the materials filed, it appears that Laura’s incumbent lender was itself under financial distress, and it was suggested that its actions leading up to the filing of an application for the appointment of a receiver on August 7 were precipitous and dismissive of the possibility of a viable underlying business, though the fact that Laura’s business was in need of restructuring was not in dispute. The court materials indicate that there were many other disputes between the incumbent lender and the company.
Prior to the filing of the receivership application, Laura had been in contact with one of its largest landlords about providing some form of financial support to the company. The incumbent lender was advised of this but apparently refused to permit any funding to be advanced to Laura in priority to its existing security. When it became apparent that the interests of the company and the incumbent lender were going to collide, the company sought financial support from the landlord in the form of a priming DIP, conditional on continuing the proceedings under the CCAA, among other things. On August 12, the Quebec Superior Court made an initial order authorizing a priming DIP in the maximum amount of $10 million.
Perhaps the most interesting aspect of the case from the landlords’ perspective was the fact that the landlord was not only prepared to critically examine the financial viability of the company’ business, but to back up the conclusions of its analysis with funding. One might argue that there is little risk in funding in priority (particularly when you can collect a 3 per cent restructuring fee); however, the speed with which the landlord was able to react was of huge benefit to Laura and ultimately to the survival of the business. As an addendum, both the incumbent lender and the landlord were refinanced in full by a comprehensive third party DIP approximately 2.5 months later, and Laura’s plan was implemented in late November 2015.
In the cases of Nine West and Rockport, landlords were active in discussions with the companies and I understand offered rent concessions if they would be of benefit to the restructuring. In each case these offers were refused. In the case of Nine West, its NOI filing was followed by a motion seeking an order liquidating the Canadian business in its entirety.
Rockport is a Part IV filing under the CCAA. At the time of writing, approval of a sale process under the U.S. Ch.11 proceedings was pending with an intention to market Rockport’s assets as a whole rather than separately based on geography.
The takeaways are these:
- The landlord knows the debtor’s business from a financial perspective;
- The landlord has access to quick, available financial resources and a flexible means of deploying them; and
- The landlord is well-advised and very familiar with the restructuring process.
All of which makes them uniquely capable of executing the kind of interventions we saw in the Laura case, or even partnering with a potential acquirer, which was a possibility discussed in the Sears matter.
So, why are these cases so rare? The answer probably lies in the infrequency of the right circumstances in which to participate. Given the circumstances in Laura where there was a viable underlying business and a hostile, exit oriented incumbent lender, it is conceivable that the landlord will be the logical “white knight” the company needs.
The Official Opposition
Of further interest in the Rockport case was the U.S. bondholders’ strategy to leverage the heretofore under-leveraged Canadian assets in favour of the U.S. based DIP lender. As it appears that the Canadian entity will receive no financial benefit from the DIP, there may be issues to address as to the propriety of the structure as it affects Canadian creditors’ interests. At present, the Canadian entity is a U.S. filer and therefore Canadian creditors will be swept into the Ch. 11 proceeding under the current recognition order. However, issues have arisen as to how and why the Canadian entity would bear a disproportionate burden of the DIP, particularly where it receives no financial benefit, and where the beneficiaries are the bondholders who have recourse only to U.S. assets and would benefit dollar for dollar by payments to the DIP lender from Canadian assets. We raise these latter issues in the context of the discussion to follow.
In the Payless case, the Canadian debtors were chapter 11 filers in respect of which the U.S. court made certain “first day” orders, including an interim DIP order. The Canadian debtors sought to recognize the interim DIP order, amongst other relief pursuant to Part IV of the CCAA. This aspect of the recognition proceeding was opposed by the landlords, who unlike their Canadian creditor counterparts would see no benefit from the recognition of the interim DIP.
The relevant facts are these: Prior to the interim DIP order, the Canadian business was not a guarantor of Payless’ existing U.S. credit facilities. Following the interim DIP order, the Canadian debtors would become guarantors of the DIP, their assets would be encumbered in support thereof, and it was acknowledged that the Canadian debtors would receive no advances under the DIP. To address the effects of this transaction, certain creditors were offered “protections” which sought to lessen the adverse impact of the deal. The landlords were offered no such protections.
Notwithstanding the support of the Information Officer and the in terrorem threat that the business would suffer irreparable harm unless the DIP was recognized as is, the landlords opposed on the basis that such a structure would require that the interests of all Canadian creditors be taken into account. The hearing judge agreed, saying, “there would have to be adequate protection to ensure that all (Judge’s emphasis) Canadian creditor groups would not be adversely affected by the grant of the security.” In the Judge’s view, the benefits of recognizing the DIP should be measured against what measures had been taken to ensure creditors would not be worse off. It is worth noting the use of the words adequate protection” were likely not intended to refer to the U.S. concept of a similar name, and its rules and applications.
With that resetting of the table, the landlords and company were able to come to acceptable terms.
Occupying the role as the “official opposition” has provided the landlords (as it has done for employee representative counsel) with unique opportunities to test the legality of the debtor company’s actions and strategies as well as the integrity of the CCAA process itself.
As referred to above, the landlords in Target had entered into agreements concerning the preservation of certain guarantees in their favour which gave them recourse to the Target’s solvent U.S. parent. These agreements were embodied in changes to the initial order and established that such guarantee claims were not to be determined in the CCAA proceeding, nor released or affected in any way by any plan filed by Target Canada or its affiliates. From the company’s materials it was clear that at the time these arrangements were made, all parties, including the monitor and of course Target U.S. were involved in the coming to terms, and the monitor observed in its report that the revisions embodying the agreements in the initial order were a “fair and reasonable balancing of interests.” Finally, the original claims procedure order explicitly preserved the effect and scope of the changes to the initial order upon which the landlords relied.
However, when Target filed its plan of arrangement, it became apparent that Target intended to compromise and release the landlord’s guarantee claims in direct contradiction of the agreements and the initial order and claims procedure order negotiated by the parties.
The landlords raised a number of issues with Target’s approach, but central to these was the failure to adhere to established agreements and orders which were heretofore unamended and unabrogated, and upon which the proceeding had been conducted. Simply, the question put before the court was could a plan which sought to abrogate previous, contested orders of the court upon which the proceeding was founded and subsequently conducted be considered fair and reasonable?
The Court’s equally simple response was, “No.” The hearing judge stated, “It cannot be fair and reasonable to ignore post-filing agreements concerning the CCAA process after they have been relied upon by counter-parties or to rescind consent orders of the Court without grounds to do so” “…this Plan contravenes court orders and cannot be considered to be fair and reasonable…”
At one level one might ask how such an elementary concept could reach the point of dispute before a CCAA court, yet because it did so, the importance of well-funded, organized and well-advised creditors cannot be overstated, with the result that they were able to confirm what is (and should remain) a canon of fairness in CCAA proceedings.
A further observation is that with the exception of Sears and Laura Shoppe, the cases referred to in this article were either cross-border or deeply influenced by U.S. parent cos and their U.S. creditors and stakeholders. To the extent that strategies and approaches arrived at in the U.S., with U.S. centric objectives are rolled out in Canadian plenary or ancillary proceedings, it is of some comfort that the landlords remain vigilant of their own interests and derivatively the integrity of Canadian restructuring principles and practices.
In our practice, we are frequently advising monitors and information officers. Our advice in such retail situations is not to look at landlords as hostile constituents, but to consider them as part of the menu of solutions that can be brought to the table to develop and implement successful retail restructurings.