McNellis: The Chapter After Eleven

By John McNellis

Put Mervyns, Blockbuster and Lassie together, and what do you have? Two dogs and a money-maker. If you own retail property, what did you have with Chevys Fresh Mex, Z Gallerie, Eddie Bauer, Avenue and Gottschalks? One project-sapping bankruptcy after the next.

Before the mid-19th century, debtors unable to pay their debts were simply thrown into prison to rot until they made their creditors whole. Aside from its barbarity, this system had a drawback so obvious it should have been apparent even to the government: If a borrower couldn’t repay his debts while free, how could he possibly do so behind bars? Rather than logic, retribution was—and is—the driving force behind debtors’ prisons. The eye-for-an-eye desire remains so powerful that to this day debtors’ prisons are thriving in the United Arab Emirates and China and were only outlawed in Greece in 2008 (apparently just in time).

These prisons might have lasted a bit longer in England had it not been for the great Charles Dickens and his personal crusade against them. Dickens’ father had been jailed in the Marshalsea, an infamous debtors’ prison, and a very young Charles was scarred for life, his brilliant writing forever influenced by the dehumanizing experience.

Modern bankruptcy laws arose from the infamy of the shuttered debtors’ prisons and gradually—on the heels of one national depression after another—became a more and more powerful tool for debtors. Instead of being locked away, the tinker, tailor and even the columnist could petition to have his debts forgiven and begin anew with only a somewhat tarnished slate. For tenants today, the bankruptcy court will readily terminate a lease the tenant cannot afford or, if the tenant thinks she can survive with a reduced rent, she can seek that reduction in a Chapter 11 proceeding. The landlord has a simple choice: Accept the reduction or take the keys.

This process works swell—ok, it’s still painful but it beats debtors’ prisons—for that tinker and tailor. And as long as the debtor has just a location or two, it doesn’t work all that badly for the landlord. Yes, the landlord will get his rent whacked or his shop back, but at least he knows the tenant is truly going down (back to our hard-wired craving for revenge).

Yes, bankruptcy laws work well enough if the debtor is a one-off cobbler in Sherwood Forest and the landlord is Simon Legree. But, in the hands of today’s major retailers, they are easily converted into neutron bombs. (People killed; buildings fine.) It functions thus: Say you are the chief executive of a 2,000-store retail chain, and you can’t meet the interest payments on the hundreds of millions of dollars you borrowed to pay your owners obscenely inappropriate dividends. What do you do? You toss the company into Chapter 11, keep your 500 best stores, tear up the leases on your 500 losers, and then advise your remaining 1,000 landlords that they can either accept a financial colonoscopy, or you will dump them as well.

Faced with the choice of an empty building or getting half as much rent as they bargained for, many landlords—particularly small private owners whose lifesavings are embedded in the one building they own—will go along. Then, even though as chief executive, you’re the guy who caused all the losses in the first place, you crow to The Wall Street Journal that you’ve just saved $300 million in operating costs and—bingo—your board of directors rubberstamps your eight-figure bonus.

This works. It may not pay off like a slot machine, many bankruptcy-filing retailers ultimately fail, but among the bankrupt tenants listed above, Chevys exemplifies how even a relatively small retailer can play the bankruptcy system.

Once upon a time, Chevys was an excellent purveyor of inexpensive, fun Mexican food. Famous as a place where young couples could let their noisy toddlers and preteens run crazy while they, the exhausted parents, blissfully tanked up on margaritas; the privately owned chain did well and at one point had more than 100 restaurants nationwide.

But it was sold and sold again, the second time to a private equity firm in 1997. It sought bankruptcy court protection in 2003, shed locations in the manner described above, and the reduced chain was sold to another private equity firm in 2005. It went back into bankruptcy in 2011, shut its worst performers and gave its other landlords (McNellis Partners included) the rent-reduction-or close-ultimatum. (We caved.)

The chain emerged from its most recent bankruptcy proceedings earlier this year with only 25 restaurants and was sold yet again to another private-investor group.

Whether the masters of the universe who repeatedly bought and sold Chevys after treating it like a piggy bank ever lost a dime in its serial bankruptcies is highly questionable. There is no doubt every single Chevys landlord took a hit, some fatal.

Had Charles Dickens been born, oh, say 20 years ago to a family that owned a shopping center, he might have written of the horrors of abusive bankruptcy instead of debtors’ prisons, though probably not. Not even the great Dickens could weave a sympathetic tale about a pitiful landlord.

West Coast Commercial Real Estate News