The tenant is a credit, and most landlords never underwrite it
Three of the restaurant operators that filed for bankruptcy this autumn show where the landlord stands. Meritage Hospitality, a large Wendy's franchisee, filed on 17 September with 320 restaurants in fifteen states and about $391 million of operating lease obligations, averaging thirteen years left to run. It had closed about sixty stores before filing. Since then it has moved to reject thirty-three more leases across four motions, the court has approved the first ten, and in late October it asked for a procedure to close between twenty and sixty further loss-making stores. Objections are due 6 November. True Food Kitchen filed on 4 October and closed twelve of its forty-six restaurants that day; landlords, Simon Property Group among them, are reported to be on its list of thirty largest unsecured creditors. And in Louisville, a single-store Crumbl franchisee went straight into Chapter 7 on 1 October.
None of them was a surprise to anyone reading the numbers; almost nobody was. I spent thirty-five years on the other side of this. A distressed-debt investor underwrites a borrower continuously: quarterly numbers, covenant tests, the gap between what the company says and what the cash shows. A landlord holds a longer and less liquid exposure to the same kind of company, and usually it was underwritten once, by a broker, before signing. A ten-year lease on a restaurant pad is a ten-year unsecured loan to a restaurant operator, and it should be managed like one.
What a lender knows that a landlord does not
When a tenant files, the landlord learns three things at once, and all of them are bad. First, the lease is the tenant's to keep or drop. The tenant has four months to decide which leases to keep and which to reject, the court can add three more, and after that only the landlord's written consent extends the clock. Rejection needs only a business reason.
Second, the claim for a rejected lease is capped at the rent for the greater of one year or fifteen percent of the remaining term, never more than three years' rent, counted from the petition date or the day the keys come back, whichever is earlier, plus any rent already unpaid on that day. Courts still disagree whether fifteen percent of the term means time or money; most recent decisions say time. The claim then stands in line with every other unsecured creditor. In one retail case filed this autumn the proposed pool for all of them, rejection claims included, is $500,000.
Rent for the rest of the filing month is its own argument. In some circuits the bill arrived before the petition, so the whole month is a prepetition claim and the landlord must prove the estate benefited to be paid for the post-filing days. In others rent accrues daily and those days are a cost of the case.
Third, the cash security deposit is frozen with everything else. It belongs to the estate, and the landlord cannot touch it without the court's leave. Meritage's rejection orders say so.
What to do about it
Underwrite the entity on the lease, and keep doing it. The brand on the sign is a franchisor, and the franchisor may be a creditor competing with you: Wendy's franchisor has asserted about $147 million against Meritage. The cheapest covenant is the one asked for at signing, so I would write annual delivery of financial statements into every lease, and I would read what arrives.
Hold security that survives a filing. A letter of credit is the issuer's promise, paid from the issuer's money, and the tenant's bankruptcy stay does not stop the draw. Three drafting points matter. Do not call the letter a security deposit in the lease: a Delaware bankruptcy court this spring treated a ten million dollar letter described as security for full and faithful performance as a deposit, so the proceeds count against the capped claim. Make the draw turn on the landlord's own certificate, allow partial draws, and run the letter sixty days past the lease. And size the security against the cap; below it a letter of credit does no better than cash and costs more.
Take a guaranty from a parent or principal who is outside the case. The cap applies to the tenant; a guarantor who has not filed owes the full amount unless the guaranty itself says otherwise.
Treat early signs as events. Late rent, partial rent, a request to defer, a sale-leaseback of other locations: each is what a lender calls a trigger. Meritage did twenty-three sale-leasebacks before it filed, raising about $52 million; each was a signal to the landlords still holding its other leases. I would put a right to re-measure security into the lease, tied to a stated credit test, so that a trigger has a consequence.
Know your number before the filing. A landlord who knows what the capped claim is worth, what the security covers, and what the space would re-let for can decide in a day whether to negotiate or let the lease go.
Landlords say they are in the real estate business. For the term of the lease they are in the credit business, whether they manage it or not. This autumn's restaurant filings are what it looks like when they do not.