Dot-gones pay debts by liquidating their leases

Real Estate Weekly, Dec 27, 2000 by Natalie Keith

With office rents increasing dramatically over the past few years, some dot-coms are liquidating their leases when they go out of business rather than dissolving them.

"A lot of these leases were signed six to 24 months ago and are considered below-market," said Eric Yarbro, first vice president of CB Richard Ellis, who has worked with bankrupt dot-coms.

With office rents surging, space leased two years ago could be rented in today's bankruptcy market at rates $10 or $20 per square foot more. By filing a dot-com can capture the difference, proceeds that are passed on to its creditors.

"The problem with most dot-coms is that they don't have any assets," said Emanuel Grillo, a bankruptcy attorney with the law firm Salans. "Bankruptcy can create an asset out of the lease."

With venture capital drying up and the exuberance over business prospects for the Internet dwindling, the dot-com world is beginning to consolidate. While some companies are being swallowed up by larger ones, others are being forced to shut their doors altogether.

Some dot-coins file for Chapter 11 bankruptcy through the courts, which allows them to reorganize and emerge with the hopes of turning the business around. When a company files for Chapter 7 bankruptcy, however, the company's assets are liquidated with the proceeds going to creditors. If a company does not file for bankruptcy, the space reverts back to the landlord.

Under bankruptcy procedures, the court appoints a trustee, which oversees the bankruptcy process. Trustees then hire people like Yarbro, to determine the value of a lease or to find a new company willing to lease the space formerly occupied by the bankrupt company.

Capturing value of a below-market lease is not new, but it has intensified in the past few years because rents have increased so dramatically.

"In the past if you had a lease that was a year old, it wasn't worth much, but if you signed a lease in 1998, by 2001 it could be worth $10, $15 or $20 more a square foot," Grillo said.

For example, space at 632 Broadway that used to be leased at between $20 to $24 a square foot is being auctioned to the highest bidder, with the winning bid expected to be as high as $50 a square foot, Yarbro said.

Some have compared this situation with that of the late 1980s, when security firms went out of business following the stock market crash of 1987. When companies went out of business, banks foreclosed on property and then sold it or kept it in its own real estate portfolio. With the bankruptcy of dot-coms, courts are assuming the same role that banks did in the late 80s.

"The question is are the banks more savvy than the banks of the late 80s?" Yarbro said.

Grillo notes, however, that some landlords have become more aware about the phenomenon and have tried to include clauses in leases to ensure they will benefit if leases are reassigned.

"As more cases go through the courts, how that will shake out remains to be seen," he said.