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SIGNS OF TROUBLE

LANDLORDS ARE TRYING TO KEEP “GOING OUT OF BUSINESS” SIGNS OUT OF THEIR CENTERS

By Steve McLinden

Those garish “going out of business” signs draped across store entryways often become banners of failure for otherwise healthy shopping centers, lament landlords and property managers. And despite lease language prohibiting such sales, bankruptcy judges tend to side with the liquidating tenants, they say.

“Any real estate owner that owns lots of assets is going to run into these liquidations,” said Christopher Weilminster, senior vice president of leasing at Rockville, Md.–based Federal Realty Investment Trust. “It’s pretty ugly, and it’s not anything you want to see, but as a large landlord, it’s inevitable that these will become a part of your business. We have 300 tenants in our portfolio, and at one time or another, something’s going to happen.”

But this does not mean that center owners must shrink from seeking their contractual rights in the struggle to maintain a property’s image, sources say.

The landlords of some of the 520 stores Movie Gallery closed after filing for Chapter 11 last year asked a bankruptcy judge to rein in the retailer’s store-closing tactics. The 16 landlords, including Inland Real Estate Group of Cos. and Wal-Mart, said the court’s liquidation guidelines were “broad, unilateral and egregious” and allowed Movie Gallery to operate open-ended sales they charged would harm the integrity of the shopping centers. These owners asked that Movie Gallery be kept from using the word “bankruptcy” or any neon or Day-Glo colors on any signage. They also requested limits on sale hours.

Movie Gallery did agree to restrict its closing sales to the centers’ regular operating hours, to complete the sales events within 60 days and to restrict “the extent and content” of the related signs.

Even as U.S. courts approve going-out-of-business sales, though, they are also demonstrating regard for the shopping center operating environments; they are forbidding the stores to expand their sales out into the common areas and to conduct on-site auctions, for instance. The courts are also restricting the sale hours and the positioning of on-premises promotional sign holders, property managers say.

“After all, we work so hard to create a standard and present ourselves in the best possible light, not just to the consumer but to the local municipalities where we operate and to our other tenants,” said John Kokinchak, senior vice president of property management at Developers Diversified Realty Corp. “You hate to see all of that nullified by the stroke of the pen.”

As common practice, most landlords draft explicit language prohibiting going-out-of business sales in the “Use” or “Operation by Tenant” sections of the leases. But bankruptcy courts still favor maximizing creditor distributions and tend not to hold tenants to some of the stricter lease provisions, says Andy Graiser, co-president of DJM Realty, a New York City–based firm that is managing the sell-off of the U.S. leases of The Bombay Company, which filed for Chapter 11 in September.

This can start a legal tussle. “In certain situations, if communication between the parties breaks down, landlords will get more aggressive,” Graiser said. “But landlords generally understand what needs to get done in these sales, and that is to make sure that all of the inventory gets sold to satisfy creditors.” And often, he says, among those creditors are the shopping centers themselves.

Some law firms are better than others at communicating a landlord’s concerns to the courts and negotiating guidelines, says Weilminster. Even so, “you still see a lot of decisions that don’t serve the credibility of landlords,” he said. “Too many times a going-out-of-business sign communicates failure where there is actually success. Local newspapers often come to you and ask, ‘Is your center struggling?’ There’s a presumption that this must be deeper, when it isn’t.”

On the other hand, landlords can exert much more control over closings unrelated to bankruptcy, says Michael Fortunato, president of City Commercial Management, a Rancho Cucamonga, Calif.–based property management firm. “Landlords are reluctant to bend the rules, because they have little incentive to do so. The tenant has one foot out of the door anyway, plus these sales often present a negative image to the center.” Moreover, owners are often bracing to take a further hit once the stores close, because once occupancy dips below a certain level, co-tenant clauses kick in that will lower the rent for some tenants.

Not that owners stonewall all tenants who are being forced to liquidate or relocate, says Weilminster. “We can certainly work with them,” he said, “but we won’t allow them to tape a gigantic sign across their entrance that’s visible from an airplane.”

While REITs and other large center owners routinely insert pre-emptive store-closing language in their leases, mom-and-pop landlords generally do not think about it, says Weilminster. “And all of a sudden, they realize they didn’t account for it when one of their tenants is holding a huge going-out-of-business sale,” he said. “Unless you have been through this, you don’t always account for that possibility.”

Many states, Virginia and New York included, require a permit for going-out-of-business sales, in part to keep merchants from falsely promoting liquidation sales and profiting at the expense of same-center competitors and unwary shoppers. Sometimes the merchant does not actually close at all, but merely changes the store’s ownership or name. “These laws are largely created to protect the consumer,” Graiser said.

Occasionally, the negative impact of such store-closure sales is temporary. “A lot of times we just look at this as an opportunity to re-lease great space,” Kokinchak said. “Having the ability to capture inventory is essential, because you need to react to market demand and bring in new and exciting tenants.” It is this constant evolution of the retail formats and themes that creates the conditions for store closings, says Steve Miller, co-president of the retail group at Gordon Bros. Retail Partners, a national disposition firm.

Going-out-of-business sale guidelines vary greatly from enclosed malls to open-air centers to lifestyle and outlet centers, says Miller. “But we never use ‘lost our lease’ signs or other aggressive signage in any case,” he said. “There are acceptable ways the landlord can maintain credibility in the process, and we always try to work with them.”

Closing sales or not, conspicuous sale banners are routine year-round at shopping centers, says Miller. “You can walk through any mall and see healthy retailers in strong promotional states using prominent point-of-sale signage,” Miller said.

The key in retailer bankruptcy sales “is to consider that bankruptcy is a court of equity, not a court of law,” Miller said. “When an operator takes over a group of stores that impacts landlords, they are subject to [court-sanctioned] bidding-procedure packages put out before a buyer. And their objective is to satisfy creditors.”

Following a rash of retail bankruptcies among predominantly enclosed-mall tenants in the early 1990s, prominent retail landlords have made doubly sure that all their standard leases place restrictions on going-out-of-business sales, says Kokinchak. “But, ironically, the lease language exists to prevent the type of signage we see the court overriding,” he said. “With some exceptions, courts still allow stores to hang big banners that completely block views into the store.”

The wave of going-out-of-business sales is hardly over, says Graiser. “It is going to be a busy 2008.”