Shopping Center Legal Update

81161_ICSC-Summer.qxd V O L. 2 4 8/9/04 I S S U E 11:49 AM 2 Page 1 S U M M E R International Council of Shopping Centers, Inc. 1221 Avenue of the Americas, 41st floor, New York, NY 10020-1099 Phone (646) 728-3800 2 0 0 4 Shopping Center Legal Update The legal journal of the shopping center industry In Depth The ADA in Stadium-Style Theaters: The Evolution of Comparable Lines of Sight 2 Time and Place Really Matter in Bankruptcy 5 The Adequate Protection Provision of 361 of the Bankruptcy Code and Letters of Credit 8 Estoppel Certificates or Reality: Which Bites? 10 Shopping Centers: Use Clauses Must Be Honored in Tenants Bankruptcies 13 Pruneyard Visited in Florida: Florida Court Renders Decision Favorable to Person Seeking Mall Access 15 Is Use Restriction Unenforceable Outside of the Shopping Center? 16 13 Of Interest Article 17 Cases 17 Assignment 17 Bankruptcy 17 Condemnation 18 Covenants/Clauses 18 Fees 18 Guarantees 18 Landlord & Tenant 18 Leases 19 Options 19 Personal Liability 19 Zoning 20 26 From Canada In Depth The Rights of a Tenant Under a Registered Lease Can Take Precedence Over the Rights of a Lender 21 Judicial/Legislative Developments 24 Copyright 2004 International Council of Shopping Centers, Inc. All rights reserved. Protected under Universal Copyright Convention and other international conventions. This publication may not be reproduced in whole or in part, in any form, without written permission from the International Council of Shopping Centers. Printed in the U.S.A.

In Depth The ADA in Stadium-Style Theaters: The Evolution of Comparable Lines of Sight Daniel S. Brennan* Schiff Hardin & Waite Chicago, Illinois Shopping center landlords and tenants have addressed, in varying degrees, the requirements of accessibility of their goods and services for their disabled customers under Title III of the Americans with Disabilities Act ( ADA ). In some cases, compliance with the ADA requires a survey of existing facilities to determine whether the removal of certain architectural barriers is readily achievable. For new construction started after the effective date of the Americans with Disabilities Act Accessibility Guidelines ( ADAAG ), compliance means ensuring that the design and construction includes accessible elements such as appropriate parking, accessible routes and entrances, and other features. Some sections of the ADAAG are not, however, a model of clarity; and the question of compliance is difficult to answer. This has proven especially true for movie theater chains that design, build and operate stadium-style theaters. Stadium-style theaters feature seats that are built on stepped platforms that rise at relatively steep angles from the front to the back of the theater. Patrons typically enter and exit the theater using an aisle that connects to the theater near or at the bottom of the seating area. Wheelchair seating areas are usually provided at or near the area where the aisle meets the seating area. This area is usually sloped, runs across the width of the theater and is commonly located very close to the movie screen. In smaller stadium-style theaters, this is the only wheelchair seating area. The intent is to provide the wheelchair users with an unobstructed view of the screen. Most of the theater patrons, however, use the seats that are accessible only by using stairs. Stadium-style theaters are considered to be assembly areas under the ADAAG. Those theaters must have seating for wheelchair users, which provides comparable lines of sight to those afforded members of the general public. Section 4.33.3 of the ADAAG provides the following requirements for wheelchair seating in assembly areas such as stadium-style theaters: Wheelchair areas shall be an integral part of any fixed seating plan and shall be provided so as to provide people with physical disabilities a choice of admission prices and lines of sight comparable to those for the general public. (emphasis added) The approach that many theater chains have taken to provide lines of sight comparable to those for the general public is a design, described above, that allows unobstructed views of the screen for wheelchair users in stadium-style theaters. Guidance From the Courts Or the Lack Thereof Some courts have agreed that the ADAAG requires only unobstructed views of the screen for wheelchair patrons. For example, in Lara v. Cinemark USA, Inc., 207 F.3d 783 (5th Cir. 2000), the Department of Justice, which is charged with enforcing Title III of the ADA, brought suit against one theater operator, claiming that unobstructed views of the movie screen were insufficient to comply with 4.33.3 of the ADAAG. The Department of Justice argued that viewing angles had to be comparable as well. The Fifth Circuit rejected the position of the Department of Justice. The court reasoned that viewing angles were a new component of the department s interpretation of 4.33.3. As evidence of this, the court noted that, in 1999, the U.S. Access Board, the federal agency that reviews and updates the ADAAG, issued a Notice of Proposed Rulemaking that Shopping Center Legal Update is published by the Legal Department of the International Council of Shopping Centers, Inc., 1221 Avenue of the Americas, 41st floor, New York, New York, 10020-1099; James E. Maurin, Chairman; Michael P. Kercheval, President; Melina Spadone, General Counsel. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Editor-in-Chief: Stephanie McEvily, Esq. Spring Issue Editors: Daniel K. Wright II, Arter & Hadden LLP, Cleveland, OH; Ashley Stanley, Hartman, Simons, Spielman & Wood, Atlanta, GA; Steve Snively, Holland & Knight, LLP, Orlando, FL; William Crowe, Mayo, Gilligan & Zito, Wethersfield, CT; Joshua Stein, Latham & Watkins, New York, NY; Doug Ulene, Willkie Farr & Gallagher, New York, NY; Thomas Barbuti, Whiteford, Taylor & Preston, LLP, Baltimore, MD. Summer Issue Editors: Kevin P. Groarke, Sonnenschein Nath & Rosenthal, New York, NY; Karen L. Stephenson, Katten Muchin Zavis, Los Angeles, CA; Elizabeth Belkin, Piper Rudnick, LLP, Chicago, IL; Gregory Pressman, Schulte Roth & Zabel, New York, NY; Eric Rapkin, Akerman Senterfitt, Ft. Lauderdale, FL; Dana Sack, Sack, Miller and Rosendin, LLP, Oakland, CA. Fall/Winter Issue Editors: Marilyn Sticklor, Goulston & Storrs, Boston, MA; David Huprich, Thompson Hine, LLP, Cincinnati, OH; Marty Denis, Barlow, Kobata & Denis, Chicago, IL; Mark De Pillis, Ballard, Spahr, Andrews & Ingersoll, LLP, Philadelphia, PA; Sean Ervin, The Katz Law Firm, Shawnee Mission, KS; Gary Glick, Cox, Castle & Nicholson, LLP, Los Angeles, CA; Gary Kessler, Kessler Collins, Dallas, TX. Canadian Editors: Fredric L. Carsley, Mendelsohn, Montreal, Quebec; Murray F. Tait, T&T Properties, Alberta, Canada; Natalie Vukovich, Daoust Vukovich, LLP, Toronto, Ontario. 2

proposed modifications to the ADAAG. In the preamble to these proposed modifications, the U.S. Access Board stated that it was considering specific requirements to include in the updated 4.33.3 to comport with the Department of Justice s position that wheelchair seating must have comparable viewing angles. The court believed that the Department of Justice was essentially imposing a new requirement not merely interpreting an existing requirement. More recent court decisions, however, have disagreed with Lara. In Oregon Paralyzed Veterans of America v. Regal Cinemas, 339 F.3d 1126 (9th Cir. 2003), the Ninth Circuit held that 4.33.3 does require that viewing angles be taken into account to determine whether a stadium-style theater provides comparable lines of sight. In that case, the Ninth Circuit reversed a summary judgment ruling from the district court that was based upon Lara. The Ninth Circuit s opinion was based in part on literature from the movie industry, which described acceptable viewing angles in terms of desirability and physical comfort. That literature strongly suggested that wheelchair patrons in stadium-style theaters confined to the first few rows not only had the least desirable viewing angles but were also in physical discomfort as a result. The Ninth Circuit also rejected the rationale of the Lara court that the U.S. Access Board s 1999 pronouncement regarding the Department of Justice s interpretation of 4.33.3 was a sea change. Rather, the Ninth Circuit stated that 4.33.3 was broadly worded and could and should be applied to stadium-style theaters in the manner that the Department of Justice espoused. Most recently, in November 2003, the Sixth Circuit also sided with the Department of Justice in holding that viewing angles, not just unobstructed views, factor into the determination of comparable lines of sight. That decision, U.S. v. Cinemark, USA, Inc., 348 F.3d 569 (6th Cir. 2003), flatly rejected Lara and addressed a number of statutory, regulatory and equitable principles that are important for theater owners and operators to understand. In Cinemark, the Department of Justice filed suit against the movie theater chain seeking broad relief, including (i) a declaratory judgment that Cinemark violated Title III of the ADA by designing, constructing and operating its stadium-style theaters in a manner that discriminates against wheelchair users; (ii) an order requiring Cinemark to bring its stadium-style theaters into compliance; (iii) an injunction prohibiting Cinemark from designing or building any more stadium-style theaters unless those theaters were in compliance with Title III of the ADA; (iv) compensatory damages for persons with disabilities who suffered discrimination as a result of Cinemark s violations of Title III; and (v) a civil penalty. Not surprisingly, Cinemark vigorously contested the allegations. In the district court, Cinemark prevailed on a summary judgment motion. The district court held that Cinemark s stadium-style theaters complied with ADAAG Section 4.33.3 because they provided patrons that use wheelchairs with unobstructed views of the movie screen from wheelchair seating located amidst or adjacent to seating for the general public. Cinemark, 348 F.3d at 575. On appeal, the Sixth Circuit reversed and remanded. The Sixth Circuit began its analysis with that seemingly unassailable analytical approach the plain language of the regulation. According to the court, comparable in 4.33.3 of the ADAAG means similar. The regulation, thus, is plain in its requirement that the wheelchair lines of sight be similar, or at least roughly similar, to those of other patrons. The criteria for evaluating similarity, moreover, while not explicit in the regulation, doubtless include viewing angle. Id.at 576. In support of this plain language interpretation, the court cited a number of design texts on movie theater design that discuss lines of sight in the context of viewing angles. The Sixth Circuit also reasoned that accounting for viewing angles to measure comparable lines of sight was more consistent with the goals of Title III of the ADA than merely providing unobstructed views. Persons using wheelchairs are entitled to the full and equal enjoyment of public accommodations. Being forced to sit in fixed seating located near the movie screen with uncomfortable viewing angles does not, in the Sixth Circuit s view, provide full and equal enjoyment. Like the defendant in Lara, Cinemark argued that the Department of Justice had essentially promulgated a new version of 4.33.3 of the ADAAG by requiring similar viewing angles without the formal notice and comment process required under federal administrative law. Cinemark cited the U.S. Access Board s 1999 Notice of Proposed Rulemaking, which was relied upon by the Lara court. Cinemark argued that the fact that the U.S. Access Board was seeking to change the language of 4.33.3 to reflect the Department of Justice s position was evidence that the existing language of 4.33.3 did not require comparable viewing angles. The Sixth Circuit rejected this argument, concluding that the Department of Justice s interpretation of a regulation that it was authorized to enforce was entitled to deference. The proposed language changes from the U.S. Access Board were to make the section more specific on comparable lines of sight not to change the nature of the requirement itself. The other significant argument that Cinemark advanced was that it designed and built many of its stadium-style theaters in accordance with the Texas Accessibility Standards, which contained a version of 4.33.3 that was modeled after the same section in the ADAAG. The Texas standards were reviewed and certified by the Department of Justice. Title III of the ADA empowers the Department of Justice to certify that state or local codes meet or exceed the ADA requirements. Compliance with a state or local code that the Department of Justice has certified is rebuttable evidence of compliance with Title III of the ADA. Cinemark essentially argued that the Department of Justice should be estopped from arguing that Cinemark s stadium-style theaters did not comply with the ADA if those theaters complied with the Texas standards that the Department of Justice certified. The Sixth Circuit rejected this argument. The case was remanded to the district court with instructions that it was to fashion the appropriate remedy. The appropriate remedy clearly weighed on the minds of the judges of the Sixth Circuit. Throughout its opinion, the court restated verbal commitments that were made to the court by Department of Justice lawyers to consider cost and feasibility of any remedies such as simply moving wheelchair seating to the first elevated row in the theater. Additionally, the court expressed some con- 3 Shopping Center Legal Update Vol. 24 Issue 2 Summer 2004

cerns about prior action or inaction from the Department of Justice regarding the interpretation and application of 4.33.3. Ultimately, the Sixth Circuit observed that in fashioning any remedy the district court, as a court of equity, can take into account previous advice and representations by the government upon which Cinemark or this court reasonably relied. Now What? The federal appeals courts are now split on what comparable lines of sight means under 4.33.3 of the ADAAG for stadiumstyle theaters. The theater companies involved in Oregon Paralyzed Veterans of America v. Regal Cinemas filed a petition for a writ of certiorari with the U.S. Supreme Court, but no decision has been made on whether the high court will take the case. In the absence of clear direction from that court, theater owners and their landlords face a number of tough issues in connection with stadium-style theaters and compliance with ADA. The lesson from the Oregon Paralyzed Veterans of America v. Regal case is that stadium-style theaters, as most of them are currently designed, violate ADA, at least in the Sixth and Ninth Circuits. If that is the case, theater owners and operators could face copycat lawsuits that rely on these two court decisions to force a change in theater configuration or simply extract a nuisance settlement. This is not just a risk only for the theater owners; it is also a risk for shopping center landlords because the ADA makes the landlord, as owner of the property, responsible to third parties for ADA compliance. The landlord can transfer this risk to the tenant through the lease, but the landlord cannot avoid being named in a lawsuit. If the Supreme Court decides to resolve the issue and follows the Oregon Paralyzed Veterans and Cinemark cases, the question of the appropriate remedy will likely still linger. Should the relief be prospective only or should the relief require alteration of existing stadium-style theaters? The Cinemark court recognized the equitable issues that are raised in fashioning a prospective remedy. At one extreme, a court could order partial destruction of stadium-style theaters to install wheelchairaccessible seating interspersed throughout the riser sections of the theater. This remedy would entail installation of ramps and perhaps elevators or platform lifts on the other hand, if the representations that the Department of Justice made to the court in Cinemark are to be believed, perhaps a less expensive and burdensome remedy, such as installing wheelchair accessible seating in the first elevated row of seating. The resolution of this issue could have a significant impact on the financial viability of existing or future stadium-style theaters. The cost to renovate existing theaters will impair the revenue stream from those theaters in the short term. Longterm revenue could also be adversely impacted if the total number of seats in a stadium-style theater is reduced to accommodate additional wheelchair seating. If future stadium-style theaters will need additional wheelchair seating for ADA compliance, the financial projections for those theaters will need to factor in the cost to install such seating and the impact of such seating on revenue. No easy answer exists for wheelchair seating in stadium-style theaters. Wheelchair patrons appear to have legitimate complaints about viewing angles. Theater operators rightfully argue that the lack of a prospective, pre-construction compliance review for the ADAAG by the appropriate agency (such as is the case with a building code) puts them in a precarious position. For lawyers counseling theater owners, perhaps the best advice is to work with their architects and financial advisors to anticipate the need for additional wheelchair seating in future stadium-style theaters, and to implement that seating in a cost-effective manner that allows for acceptable revenue generation from that theater. Easier said than done! *Daniel S. Brennan is a member of the law firm of Schiff Hardin & Waite in Chicago. 4

Time and Place Really Matter in Bankruptcy Sheila Carson* Lowenstein Sandler PC Roseland, New Jersey Issue While a landlord on a non-residential real property lease is entitled to payment of obligations arising under the lease between the commencement of a debtor-tenant s bankruptcy case and the date the lease is either assumed or rejected by the debtor-tenant, the magnitude of the recovery depends on the date or the timing of rejection and in which jurisdiction the bankruptcy is pending. Consider the following scenario: The debtor a tenant exercises its statutory right to reject the lease, in accordance with the Bankruptcy Code ( Code ), effective as of the second day of the month. The debtor contends that it is obligated to pay only two days rent for the month (through rejection) with the remainder of the month s rent included in the landlord s rejection damage claim. However, courts have been unable to agree as to whether the debtor is obligated to pay only the two days rent, as an administrative claim (paid in post-petition real dollars), or the entire month s rent, which came due before the lease was rejected. In the Ames case, one of many issues addressed was the landlords assertion that because the rejected leases required that monthly rent be paid in advance on the first day of the month, the rental payment for the full month was due in full as an administrative expense of the estate, even though the debtor lost its right to occupancy upon its mid-month rejection of the leases. In re Ames Department Stores, Inc., et al., 2004 WL 361247 (Bankr. S.D.N.Y.). Ames and its non-landlord creditors countered that requiring payment in full would grant a windfall to the landlords, and that monthly rent should instead be prorated through the rejection date. Ames Holding The Ames Court held that where a claim for payment pursuant to 365(d)(3) of the Code is made after rejection of the lease (as opposed to while the debtor is continuing in occupancy), the debtor s liability under 365(d)(3) of the Bankruptcy Code is limited to the pro rata accrual for its occupancy obligations in the post-petition, pre-rejection period. Accordingly, the court held that Ames was not liable for obligations relating to the time after the debtor-tenant s rejection though if timely request had been made by the landlord for payment in full of 365(d)(3) obligations while the debtor-tenant was still in occupancy, the court would have required payment by the debtor in full, subject to disgorgement in the event of subsequent rejection and any resulting overpayment to the landlord. Key Facts The material facts were undisputed, so the court did not conduct an evidentiary hearing. In an effort to market its numerous retail leases, Ames explored numerous marketing options. In connection with the marketing efforts, the court approved expedited rejection procedures for leases that Ames was unable to sell. Pursuant to the rejection procedures, Ames sought to reject the two leases at issue in the court s opinion, and served rejection notices on the landlords. Ames vacated the premises and returned the keys to the landlords on the same day it served rejection notices. As to the first lease, Ames vacated on the 20th day of the month; as to the second lease, Ames vacated on the 4th day of the month. In each instance, Ames failed to pay rent that had come due on the respective lease on the first day of the month in which the premises was vacated. The landlords each filed timely objections to the rejection notices, contending, inter alia, that unpaid administrative expense obligations, including payment in full of the rent that was due under each lease on the 1st of each month (not just the pro rata portion allocable to the period of pre-rejection occupancy), had to be satisfied as a condition to rejection. The court permitted the rejections to be deemed effective on the respective dates specified in the rejection notices, but this decision was without prejudice to the landlords requests for payment, as administrative expenses, of any sums they contended would be due for post-petition rent. Without objections from Ames or the landlords, the court converted the motions into motions for the payment of administrative expenses. Analysis Treatment of Post-petition Obligations In reaching its conclusion, the court rejected the landlord s argument that the debtor was required to comply with lease obligations (payment for the month in advance) because such obligations were burdensome to the debtor and were the reason for the lease rejection in the first place. The court noted that rejection of a lease is a court-authorized breach. Where an exer- 5 Shopping Center Legal Update Vol. 24 Issue 2 Summer 2004

cise of business judgment makes this breach advisable, the debtor can be relieved of the duty of continuing to perform under the lease, and the landlord s claim for damages resulting from the rejection will be treated as a pre-petition, general unsecured claim as provided by the Code. Although the court noted that a debtor must comply with post-petition lease obligations, the court commented that the right to reject burdensome leases is one of the most fundamental rights given to a debtor in bankruptcy. It reasoned that to compel a debtor to comply with the obligations under a burdensome lease the debtor has elected to reject frustrates the policy reasons for allowing a debtor to reject a lease under the Code. Ames rejected each of the leases in mid-month, and vacated the premises on or before the date of rejection. Ames conceded that it was liable, as an administrative expense, for the portion of unpaid post-petition rent allocable to the period through the date of rejection. As to the post-petition rent, under 365(d)(3) or otherwise, that would be allocated to the post-rejection period, the Ames Court followed four out of five Southern District bankruptcy courts (three in holding plus one in analysis) in holding that a debtor-tenant is liable only for obligations under 365(d)(3) that relate to the period through the date of rejection in other words, the 365(d)(3) duty to pay post-petition lease obligations, when addressed after rejection, must be prorated to cover only the portion allocable to the pre-rejection period. In reaching its conclusion, the Ames Court pointed to cases in other jurisdictions that have held similarly. See, e.g., NETtel, 289 B.R. 486 (Bankr. D.D.C. 2002); In re All for A Dollar, Inc., 174 B.R. 358, 361-62 (Bankr. D.Mass. 1994); In re Child World, Inc., 161 B.R. 571, 576 (S.D.N.Y. 1993), rev g 150B.R. 328, 333 (Bankr. S.D.N.Y. 1993); In re Almac s, Inc., 167 B.R. 4, 8 (Bankr. D.R.I. 1994); In re William Schneider, Inc., 175 B.R. 769, 772 (S.D. Fla. 1994); In re Warehouse Club, Inc., 184 B.R. 316, 318 (Bankr. N.D.Ill. 1995). Statutory Construction As is typical, the Ames Court began its analysis by reviewing the words of the relevant statutes. First, the court looked to 365(d)(3) of the Bankruptcy Code, which provides, in relevant part: [t]he trustee shall timely perform all the obligations of the debtor arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title. [11 U.S.C. 365(d)(3)] The court concluded that 365(d)(3) is ambiguous especially when this section is considered along with 365(g) and 502(g), although the court noted that jurisdictions are split on this issue. Upon accepting that 365(d)(3) is ambiguous, the Ames Court considered the legislative history and determined that 365(d)(3) was enacted to fix the amount to be paid by debtor-tenants pending assumption or rejection at the amount provided in the applicable lease; to require payments to be made at the time required under the lease (not after confirmation); and to remove the bankruptcy court s power to review the amount to be paid as administrative rent to determine its reasonableness. According to the court, consideration of the legislative history plainly indicates to what the clause notwithstanding section 503(b)(1) of this title refers, and it plainly was not to do away with the hardly-offensive concept of prorating. The Ames Court also commented that it was compelled to apply post-rejection proration for a variety of other reasons: First, the court s need to implement 365(g) and 502(g) of the Bankruptcy Code, which require that claims for breaches of lease obligations be treated as pre-petition claims. Yet, requiring payment for obligations in the post-rejection period would be to render those provisions irrelevant, elevating landlords rejection claims over the claims of other unsecured creditors. Second, the logical rationale of 365(d)(3) provides payment for current services. Logically, a landlord is not providing current services after rejection when a landlord is free to re-let its premises to another tenant. Third, the court was concerned that after it found 365(d)(3) to be ambiguous and declined to permit post-rejection proration which would provide a windfall to the Ames landlord other landlords in other factual scenarios may be disadvantaged by such an approach. Some lease obligations, such as base rent and sometimes real estate taxes, can be anticipated and billed in advance, requiring the debtors to pay for a period preceding the time of rejection. However, the amount payable on other lease obligations, especially percentage rent, may be ascertainable only in retrospect, and may thus be billed by landlords in arrears. Depriving landlords of such payments for post-petition, pre-rejection obligations, based on the possibility that they could not be determined in advance and billed prior to rejection, would be unfair to landlords just as billing debtors for post-rejection occupancy is unfair to other creditors. According to the Ames Court, there is no indication that Congress intended such a result when it enacted 365(d)(3). Fourth, when obligations billable to the tenant are allocable to periods extending in advance, the results may be absurd. Real estate taxes, for example, are often billed as much as six months to a year in advance. Finally, the Ames Court adopted the persuasive reasoning set forth in the NETtel case, supra., which concluded on similar facts that rent arises for purposes of 365(d)(3) in an accrual sense, meaning during the corresponding period of occupancy in [the] postrejection period. 6

Rejection of Minority View In reaching its holding, the Ames Court analyzed and rejected contrary courts of appeal holdings in Koenig Sporting Goods, 203 F.3d 986 (6th Cir. 2000) and HA-LO Industries v. Centerpoint Properties Trust, 342 F.3d 794 (7th Cir. 2003). In rejecting these viewpoints, the Ames Court noted that these decisions are not distinguishable on their facts in any meaningful way, but that their reasoning was unpersuasive. The Koenig Court, for example, held that 365(d)(3) was unambiguous on its face, and went on to establish the billing date approach to determining that post-rejection amounts that were billed pre-rejection should be treated as administrative claims. Similarly, in HA-LO, a 2003 decision of the Seventh Circuit (by a panel with no overlap with the Seventh Circuit panel that decided the Handy Andy case) involved similar facts to Ames. The HA-LO Court, like that in Koenig, started with the principle that 365(d)(3) is unambiguous. The HA-LO court addressed the earlier decision of the Seventh Circuit in Handy Andy, 342 F.3d 794 (7th Cir. 2003), rejecting the argument that Handy Andy was controlling. In an effort not to contradict Handy Andy directly, the HA-LO Court attempted to find a common ground between its holding and that of Handy Andy. In rejecting the HA-LO analysis, the Ames Court pointed out that the HA-LO Court did not distinguish or even cite the NETtel case. In NETtel, the court held that rent arises for purposes of 365(d)(3) during the period of actual occupancy (i.e., rent is prorated). In re NETtel Corp., Inc., 289 B.R. 486, 489 (Bankr.D.D.C., 2002). Extrapolating NETtel further, the Ames Court rejected the HA-LO Court s attempt to distinguish between tax reimbursement obligations and base rent, noting that the same approach should be applied no matter what type of lease obligation was addressed. Although most courts now apply the proration method, a substantial minority of courts require that a debtor pay in full all bills received from the landlord between the date the debtor files its Chapter 11 petition and the date of rejection, regardless of the language in the lease and regardless of the time period to which the bills actually relate. The Third Circuit is aligned with the courts, such as HA-LO, which have opted for the billing date approach. Centerpoint Props. v. Montgomery Ward Holding Corp., 268 F.3d 205, 213 (3d Cir. 2001). In Montgomery Ward, the Third Circuit followed Koenig in holding that an obligation arises under a lease when the legally enforceable duty to perform arises under the lease. Because of the continued differences in the law on this issue, it is critical that landlords and their counsel pay close attention to the applicable law and facts when faced with the perils of a tenant in bankruptcy. As shown, not only is the timing of rejection a key factor, but the location of the bankruptcy also has a significant influence. *Sheila Carson is an attorney in the Bankruptcy, Financial Reorganization and Creditors Rights Practice Group at Lowenstein Sandler PC in Roseland, N.J., and New York City. She has a broad-based practice and frequently represents commercial landlords in bankruptcy cases. 7 Shopping Center Legal Update Vol. 24 Issue 2 Summer 2004

The Adequate Protection Provision of 361 of the Bankruptcy Code and Letters of Credit Gary A. Goodman* and Daphnee Surpris** Sonnenschein Nath & Rosenthal New York, New York Landlords routinely require security deposits from their tenants. In recent years, more often than not, those security deposits are in the form of standby letters of credit ( LOC ). Since it is generally prohibitively expensive for the standby LOC to have a term co-equal to that of the term of the lease, tenants request that landlords accept, and landlords generally will accept, socalled evergreen LOC (i.e., letters of credit having a one-year term that is automatically renewable for additional one-year terms until after the expiration date of the lease). But what happens if the tenant files for bankruptcy during the one-year term of the LOC delivered to the landlord, while the tenant is still current on payment of rent? The beneficiary of the letter of question in the case discussed below found this out to its chagrin. The adequate protection provision of 361 of the Federal Bankruptcy Code (the Code ) protects only secured creditors. Section 506(a) of the Code establishes the existence and extent of the creditor s secured claim for purposes of the adequate protection determination and defines a secured claim as an allowed claim of a creditor secured by a lien on property in which the estate has an interest. Accordingly, when a creditor elects to take a renewable LOC (or other indirect security provided by a third party) as security for the debtor s obligation, it will not be deemed to be a secured creditor under the Code in the debtor s subsequent bankruptcy proceeding, solely as the result of its interest in the LOC, and will not be entitled to adequate protection under 361, because that section applies only to secured creditors of the debtor. In New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart Convenience Stores, Inc.), 351 F.3d 86 (2d Cir. 2003), New England Dairies ( NED ), a producer and distributor of milk and other dairy products, entered into a requirements contract to supply certain dairy products to convenience stores, operated by Dairy Mart Convenience Stores, Inc., and Dairy Mart, Inc. (collectively, Dairy Mart ). Pursuant to an enforcement action for breach of the contract brought by NED against Dairy Mart in the Federal District Court of Connecticut, Dairy Mart was ordered, as a prejudgment remedy under an applicable Connecticut statute, to post bond, an LOC or other security approved by the court in the amount of $2,750,000. Dairy Mart elected to furnish an LOC with NED named as beneficiary. NED then became concerned that the one-year LOC would expire before the pending litigation was concluded, or might be unenforceable if a bankruptcy proceeding was filed by or against Dairy Mart. NED sought an order directing Dairy Mart to issue a revised LOC that would allow a draw-down if Dairy Mart ever failed to renew it or if Dairy Mart filed for bankruptcy. In response, the district court ordered that Dairy Mart renew or replace the LOC 60 days before its expiration, as necessary, during the life of the litigation. During the pendency of the litigation regarding the breach of the contract, Dairy Mart filed a Chapter 11 bankruptcy petition and, as a result, Dairy Mart declined any further renewal of the LOC. Dairy Mart immediately sought to lift the automatic stay to enable the district court to proceed with the pending litigation and issue a judgment in the contract action. Although the bankruptcy court granted the motion and authorized Dairy Mart to pay certain pre-petition secure debts, NED still had to await the Connecticut judge s decision and judgment. The terms of the LOC provided that it could not be drawn upon until 60 days after final judgment or, if Dairy Mart pursued an appeal, 60 days after affirmance. Therefore, NED could not draw on the LOC until a final judgment had been entered by the district court in the contract action. In the meantime, the LOC would expire unless it was renewed before the current expiration date. Concerned that the judge in the breach of contract action would not enter judgment in time and that Dairy Mart would not renew the LOC (as required), NED made a motion in the bankruptcy court, seeking alternative relief (i) compelling Dairy Mart to comply with the district court s prejudgment remedy order by renewing its security as adequate protection; or, in the alternative, (ii) granting relief from the automatic stay under 362 of the Code to allow the Connecticut court to enforce his own order; or (iii) granting equitable relief under 105(a) of the Code, which gives the court equitable power to issue any order, process or judgment that is necessary or appropriate to carry out the provisions of the Code. The bankruptcy court denied NED s motion, assuming, but not deciding, that NED was a secured creditor for purposes of seeking adequate protection under 361. The bankruptcy court held that the obligation to provide a replacement LOC was not itself collateral but was instead a dischargeable obligation, because granting the requested relief would result in a post-petition preference for NED s claim. The bankruptcy court also ruled that 105(a) was not applicable because that section does not provide relief on its own and NED s motion had not specifically invoked any other provision of the Code. Moreover, 105(a) limits the bankruptcy court s equitable powers, which must and can only be exercised within the confines of the Code. Accordingly, the bankruptcy court ruled that, even if 105(a) were applicable, the equities did not favor NED because it could not have sought additional relief from the district court but had failed to do so. 8

NED then filed an emergency appeal to the U.S. District Court for the Southern District of New York. The district court affirmed the bankruptcy court s ruling in all respects. Thereafter, the Connecticut district court issued its ruling in the contract action, finding that Dairy Mart had breached the contract and awarded NED damages in the amount of $960,000 for lost profits. The LOC expired the next day, 60 days before NED was entitled to draw on it. NED then filed a timely notice of appeal to the Second Circuit. On appeal, NED challenged the bankruptcy court s order and the district court s affirmance denying its (i) adequate protection motion, (ii) relief from the automatic stay motion and (iii) equitable remedies motion. The Second Circuit agreed with the bankruptcy court that NED was not entitled to adequate protection but, contrary to the bankruptcy court s conclusion, ruled that NED was ineligible to receive adequate protection because it was not a secured creditor as defined by the Code. The Second Circuit ruled that NED s only interest was in an LOC and that it had no direct interest in any of the property of Dairy Mart. The Second Circuit further ruled that the LOC created a conditional claim on the assets of the bank; it did not create a security interest in the assets of NED. Accordingly, the Second Circuit ruled that NED was not entitled to adequate protection under 361 because that section protects only secured creditors and provides that a party is entitled to adequate protection of its security interest when the automatic stay endangers an interest of an entity in property of the estate. The Second Circuit also ruled that NED was not entitled to relief from the automatic stay because it had no interest in Dairy Mart s property. Additionally, the court of appeals rejected NED s assertion that it was entitled to relief under 105(a). The Second Circuit held that, although 105(a) gives the court equitable power to issue order, process or judgment that is necessary or appropriate to the carry out the provisions of the Code, the exercise of that power must be tied to a general bankruptcy concept or objective. Therefore, a party must be able to show that it is entitled to substantive relief under one of the provisions of the Code before 105(a) can be triggered. The Second Circuit further held that, even though NED s motion might have implicated 361 and 362, those provisions were not successfully invoked. Therefore, 105(a) affords NED no independent relief. The court s ruling in the Dairy Mart case should serve as a cautionary tale for a landlord that is taking a standby LOC as a security deposit where the landlord anticipates that it will be necessary to renew or replace the LOC periodically until the tenant s obligations to the landlord are extinguished. As a precautionary measure, a landlord should insist that the LOC states that it is irrevocable and unconditional, immediately payable upon presentation of a sight draft by the landlord and is not subject to any further conditions. *Gary A. Goodman is a real estate partner in the New York office of Sonnenschein Nath & Rosenthal at 1221 Avenue of the Americas, 24th Floor, New York, N.Y. 10020. **Daphnee Surpris is an associate with the firm, specializing in bankruptcy. 9 Shopping Center Legal Update Vol. 24 Issue 2 Summer 2004

Estoppel Certificates or Reality: Which Bites? Kevin P. Groarke* Sonnenschein Nath & Rosenthal LLP New York, New York Today, the use of estoppel certificates in commercial real estate transactions is widespread. After all, the prospective purchaser or lender is relying on the leases of the shopping center or other commercial property and the cash flows they generate in making its decision to purchase or lend. The seller or borrower will have made disclosure to the seller or lender with respect to the property leases and other economic and operational information pertaining to the property, including delivering copies of all of the property leases, rent rolls, income and expense statements, and the like, and will have made formal representations and warranties in the purchase and sale agreement or loan agreement, which are generally backed up with post-closing indemnification obligations and/or are part of the non-recourse carveouts in mortgage loans. Routinely, the prospective purchaser or lender will require the seller or borrower to obtain an estoppel certificate from all or most of the tenants in order to confirm independently various important matters concerning the tenant s lease. The tenant s obligation to deliver an estoppel certificate at the request of the landlord (and perhaps the precise contents thereof) is generally set forth in the lease, whether the lease was drafted by the landlord or the tenant. In fact, today, it is not unusual for the tenant to have a reciprocal right to request an estoppel certificate from the landlord. The lease provision will also prescribe the consequences and remedies available in case the party requested fails to deliver the estoppel certificate in a timely fashion. Contents of Certificate A typical estoppel certificate for a multi-tenant shopping center, whether in a sale or financing context, will seek independent confirmation from the tenant of such lease matters as (1) the identity of the lease documents that the copy of the document(s) attached to the certificate (the preferred way) or listed in the certificate is a true and complete copy/description of the lease ; (2) the lease commencement date and the termination date; (3) the existence of extension or renewal options; (4) the existence of space expansion rights; (5) the existence of any go dark or termination rights; (6) the payment of fixed rent and additional rent through a specified date and that nothing has been prepaid beyond 30 days; (7) whether there are any rent credits due the tenant and the amounts thereof; (8) whether the landlord has any construction obligations under the lease and whether they have been completed; (9) confirmation that there are no defaults by the landlord or the tenant under the lease; (10) the amount of security deposit, if any, posted by the tenant; (11) whether the tenant has any pre-emptive rights or rights of first refusal for additional space or to purchase the building; (12) whether the lease has been assigned or any space sublet; and (13) that the certificate may be relied upon by the landlord and any prospective purchaser or lender. Not unlike political pollsters, it is not unusual for the prospective buyer s or lender s form of estoppel certificate to be framed in leading or closed-end terms to elicit responses favorable to such party (e.g., There is no default by Landlord of any obligations to be performed by Landlord under the lease ). Prospective purchasers and lenders routinely require estoppel certificates. The question is: Can they rely on them, and are they enforceable (do they have any bite )? Two California Cases Two recent California state court decisions addressed disputes involving substantial lease rights, which turned on the courts resolution of inconsistencies between the estoppel certificate delivered by the tenant on the one hand and the lease and reality on the other. One case (Plaza Freeway) ruled in favor of the landlord and the other (Miner) ruled in favor of the tenant. In Plaza Freeway Ltd. Partnership v. First Mountain Bank, 81 Cal. App. 4th 616, 96 Cal. Rptr.2d 865 (Cal. App. 2000), the tenant (a bank no less) under a 25-year shopping center ground lease, pursuant to which the tenant s predecessor had constructed its freestanding bank branch building, delivered an estoppel certificate executed by its chief financial officer to the plaintiff at the time it purchased the shopping center. The certificate stated unequivocally a lease commencement date of Nov. 1, 1973, and a termination date of Oct. 31, 1998. In fact, as is commonplace, the ground lease did not specify a fixed date for the lease commencement or a fixed date for the termination of the initial 25-year term. Instead, the lease contemplated that the parties would execute and deliver to each other an addendum setting forth the exact commencement date promptly after it had occurred (on the earlier to occur of the bank s opening for business or the 180th day following delivery of the compacted pad by the landlord to the tenant). The subsequent addendum was not executed. The tenant had three successive 5-year options to renew. The tenant was required to notify the landlord of its intent to renew 12 months before the expiration date of the initial 25-year term. The bank sent its renewal notice on a date that was less than 10 months prior to the termination date it had designated in its estoppel certificate. The landlord rejected the bank s notification as untimely and, therefore, ineffective to extend the lease term. The bank followed with a second notice, which explained its view that the termination date was at least five months later than the date designated by the bank in the estoppel, based on the date the prior bank tenant had 10

opened the branch for business. The bank remained in possession of the premises beyond the termination date designated in the estoppel certificate. The landlord commenced an unlawful detainer action (a holdover case) against the bank. In ruling for the tenant, the trial court reasoned that the date designated in the estoppel certificate was inconsistent with the time frame specified in the lease, and that the landlord had failed to demonstrate any detrimental reliance on the estoppel certificate. The appellate court reversed and held that, under the estoppel certificate, the tenant was estopped from contradicting the termination date (and other facts) stated in the estoppel certificate pursuant to a statute (California Evidence Code 622) which provides, in relevant part: The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest. Cal. Evid. Code 622 (West 1995). The appellate court determined that a writing like the estoppel certificate does not have to be a two-party agreement to come within the conclusive presumption of the statute. The court noted the routine reliance that prospective purchasers and lenders place on the binding effect, and thus the reliability, of tenant estoppel certificates in commercial real estate transactions. This reliance was its rationale for applying the statutory conclusive effect to the facts stated in estoppel certificates in order to promote certainty and reliability in commercial transactions. The court stated further that Even if the estoppel certificate contains an erroneous recitation of the lease terms, the facts contained in the certificate are conclusively presumed to be true under Section 622 (emphasis added). The appellate court also determined (albeit in a footnote) that when the conclusive presumption of the California statute applies, it obviates the need of the recipient to demonstrate detrimental reliance. The court concluded that the tenant failed to exercise the renewal option on time and was, therefore, a holdover in the unlawful possession of the premises. In February 2004, the same court, which decided Plaza Freeway, decided another estoppel certificate dispute this time in favor of the tenant providing an illuminating contrast as to when estoppel certificates will be enforced. In Miner v. Tustin Ave. Investors, LLC, 116 Cal. App. 4th 264, 10 Cal. Rptr.3d 178 (Cal. App. 2004), the tenant s lease for medical office space with the landlord s predecessor gave the tenant an option to extend the lease term. In connection with the new landlord s purchase of the building in which Miner s offices were located, the tenant executed an estoppel certificate stating, among other things, that the lease was in full force and effect and also that Tenant has no options, rights of first refusal, termination or exclusive business rights, except as follows: and there followed a series of blank lines where, evidently (the record does not indicate that there were any instructions included), any renewal or extension rights or any other exception to the negative declaration should have been inserted. In the certificate signed by the tenant, these lines were left blank. Six months after signing the estoppel certificate, the tenant notified the new landlord of its exercise of the extension rights on a timely basis. The parties negotiated the rent rate for several months (the extension provision in the lease provided that the rent during the extension would be the greater of the market rent at the time of the exercise of the option or the prior rent plus 3%), but were unable to reach agreement. Then the landlord proffered a new lease with higher rent terms. The tenant rejected it and commenced an action against the landlord for declaratory relief; the landlord countered by filing a holdover action. The landlord, in its motion for summary judgment, took the position that the estoppel certificate modified or waived the express renewal rights in the lease, even though the landlord had actual knowledge at the time it purchased the building and the tenant delivered the certificate that the lease contained a renewal right. The landlord s motion relied exclusively upon the estoppel certificate, 622 of the California Evidence Code and the Plaza Freeway decision in arguing that the estoppel certificate created a conclusive presumption that Miner lost his option rights under the lease. In opposition, the tenant argued that the estoppel certificate was ambiguous as to whether he had any option rights because the estoppel certificate accurately identified the lease, that it was in full force and effect, that the certificate paragraph in question (quoted above) was intended to elicit information from the tenant about options other than those arising out of the lease because the lease spoke for itself and the landlord admittedly knew about the lease renewal option. Nonetheless, the trial court granted summary judgment in favor of the landlord, based on the estoppel certificate and the conclusive presumption in the California evidence code made applicable to estoppel certificates by the Plaza Freeway decision. In an apparent effort to distinguish the absolute conclusiveness rule stated in Plaza Freeway, the court in Miner treated the estoppel certificate as a lease amendment. It reasoned that the lease and the certificate together constituted a contract to be interpreted, then found them to be ambiguous on the extension rights and construed this ambiguity against the landlord in holding for the tenant. In both California cases, the courts narrow focus on the statutory conclusive presumption to rule in favor of the landlord in Plaza Freeway and the awkward sidestepping of the statute to rule in favor of the tenant in Miner totally eclipsed any analysis of the issues under equitable estoppel principles. The court bypassed this analysis, even though the conflicts arose from estoppel certificates and, as the court in Plaza Freeway noted, the statutory presumption derived from the common law doctrine of estoppel by contract. Courts in other jurisdictions that have considered conflicts between an estoppel certificate and the lease have analyzed the issues using equitable estoppel principles. In Bush Realty Ass n v. A.M. Cosmetics, Inc., 2 A.D.3d 270, 770 N.Y.S.2d 19 (App. Div. 2003), the Appellate Division of the New York Supreme Court reversed an order granting summary judgment by reasoning that an estoppel certificate may not be dispositive if there is an equitable basis to invalidate the certificate or if the party looking to enforce the certificate had knowledge of the defect or error when obtaining the certificate. Similarly, in Mark- 11 Shopping Center Legal Update Vol. 24 Issue 2 Summer 2004