Workers weren’t the only ones shocked when Crumbs Bake Shop decided to shut down all of its locations on Monday. Experts in commercial real estate also called it a curious move.
“It’s a little surprising that a company with retail outlets in 10 cities would announce a shutdown without first filing for bankruptcy,” said Gregory Schwed, a bankruptcy specialist at law firm Loeb & Loeb.
The baked-goods retailer has yet to formally petition for bankruptcy protection, although reports indicate the company is close to filing for Chapter 7 liquidation.
Generally, Schwed said, a company will start bankruptcy proceedings before taking such drastic measures because the process provides an orderly framework. A bankruptcy filing also prevents other potentially adverse judicial proceedings from taking place because automatic stays, which halt actions by creditors, kick in.
The retailer’s sudden move leaves question marks hanging over roughly a dozen Crumbs locations in New York City.
If Crumbs files for Chapter 11 bankruptcy protection, which gives a company greater control in unwinding its assets and liabilities, the retailer would have a period of time to continue or cancel leases it currently holds, said Jay Neveloff, a real estate lawyer at Kramer Levin. For any lease that Crumbs wants to keep, it must continue to pay the full rent until it repudiates the lease.
In that case, landlords will likely ask the judge to compel Crumbs to make a decision so they can make plans for the space, Neveloff said. Crumbs can ask the judge for more time to make a decision, however.
“Crumbs may not know where it wants to be yet and ask for adjournment for a period of time,” said Neveloff. “It could go on for months.”
Even though Crumbs went into full shutdown mode on Monday – and appears to be set to enter Chapter 7 – Schwed said it could still make sense for the company to hold on to some of its leases if the terms are favorable.
In bankruptcy law, the bankrupt party has the right to take advantage of favorable contracts and leases. That means Crumbs could assign leases to a viable third party, such as Au Bon Pain, said Schwed. Under such an arrangement, it would continue paying the agreed-upon rent to the landlord, while charging the third party higher rent and pocketing the difference during bankruptcy proceedings. A trustee assigned to liquidate Crumbs’ estate could do the same under Chapter 7.
That strategy only makes sense if the terms of the lease are favorable. Crumbs is more likely to cancel leases at locations with high rents, and would also face a stiff challenge to putting a substantially different tenant, such as a bar, in the space, said Schwed.
On Tuesday, Crain’s reported that landlords could find it difficult to lease the spaces, in part because their small size and lack of ventilation limit their use for food service. Chocolatier Max Brenner and other small food companies, such as cafés, have expressed interest in Crumbs’ New York City properties, the Commercial Observer reported.
For those leases that Crumbs dumps, landlords can file a claim for damages resulting from the termination of a lease, but those damages are limited.
“You’re not going to collect 10 years’ worth of a lease if 10 years are left,” said Raymond Sanseverino, a commercial real estate lawyer at Loeb & Loeb.
The law purposely caps the damages a landlord can collect so that claims from other creditors are not crowded out, said Schwed and Sanseverino.
If part of Crumbs’ financial woes includes overdue rent, it could be some time before landlords see that money, said Neveloff.
“For the rent that was owed prior to the [bankruptcy] filing, the landlord will become a general creditor, which means it’s going to stand in line with the rest of the general creditors,” said Neveloff. “It’s hard to tell what the recovery will be at this point.”