September 20, 2020

The One Change That Could Save Your Neighborhood Stores

For the typical small business, rent is an enormous expense, second only to payroll. And there’s no blueprint for how small-business owners should deal with their landlords during an economy-toppling pandemic.

Here’s one option: ignore your landlord and plan on resuming rent payments when sales hopefully improve, and try to not get evicted in the meantime. Another option? Stay current on rent and pray that the economy recovers before you run out of cash.

Either way, according to contract and bankruptcy law, small businesses — which employ about half our nation’s labor force — are on the hook for making rent payments in full, even if the value of commercial space they lease greatly decreases (something already happening across the United States). Entrepreneurs in hard-hit areas are at risk of losing not only their businesses but also their homes and savings. Some already have. But it doesn’t to be this way.

Large businesses benefit enormously from the flexibility afforded to them by bankruptcy law. (Most have access to “super priority” bankruptcy loans that guarantee that the business will stay afloat until the case is resolved.) The news is filled with big corporations that found themselves in deep trouble and that are now working their way out by restructuring their debts and payments. But the bankruptcy code is not as friendly to small businesses.

Chapter 11 — the type of bankruptcy that is meant to let businesses reorganize and rehabilitate rather than shut down — was recently amended so that small businesses can stay alive even if their creditors aren’t paid in full. But, crucially, these changes didn’t apply to landlords. This means a small business can’t remain in the same commercial space unless it pays everything owed under the lease, including all back rent.

This is a Catch-22 for many small businesses right now for obvious reasons: If owners are in deep enough trouble to file for bankruptcy, there’s a decent chance they don’t have the funds to pay this rent in full.

One possible solution is that Congress temporarily change bankruptcy law so that small businesses can be allowed to pay their landlords more reasonable amounts until the pandemic is behind us.

More often than not, though, small businesses shut down by simply closing their doors and walking away. In those cases, the landlord can sue the business owner for whatever is left on the lease. If the lease has been personally guaranteed, as is often the case for small businesses, the landlord can even go after the owner’s personal assets.

In a time when entrepreneurs are suffering because of circumstances beyond their control, states should temporarily expand exemptions that protect small business owners from these aggressive tactics.

In fairness, many commercial landlords are opting for a “pay what you can” model. They understand that the chances of filling empty retail space right now are slim. They may have even cut a deal on their own mortgages, allowing them to be more lenient with their tenants.

Unfortunately, some landlords are less reasonable. And, for now, aggressive landlords are enabled to do so by bankruptcy and contract law. In negotiations between two parties, if one party (the landlord) has all the power in the worst-case scenario (closure), then they also have power throughout the bargaining process because they can use that worst case as a threat.

There are ways, besides changes to the bankruptcy code, that could also lessen the power imbalance between small businesses and their landlords. State governments reinstating or extending a moratorium on evictions make sense, especially for vulnerable individuals and families. Such moratoriums don’t solve power imbalances in renegotiation, though, since businesses are still on the hook for unpaid rent.

Some retailers, including Valentino and Victoria’s Secret, have latched onto potential contractual loopholes in the hopes that they withdraw from pricey Manhattan leases. These remedies, however, require expensive lawyers that your favorite coffee shop, bookstore or florist probably can’t afford.

None of this is intended to be unsympathetic to landlords. While most commercial landlords are multi-property operations or wealthy investors, some are small businesses themselves and rely on a steady stream of rent to survive. Among the landlords being hardest on tenants, some have their backs against the wall financially because their own mortgages contain strict terms.

Local governments can help out by cutting taxes for commercial landlords in a way that benefits smaller-scale landlords the most. Still, property taxes are an important source of revenue for towns and cities, which are already in dire straits. So it’s imperative that Congress pass emergency aid for states that are weeks away from choosing between saving government employees, like teachers, and saving small businesses.

Many economists will claim in the coming months that it’s inefficient to prop up small businesses because their stores are relatively easy to replace and most do not, on paper, contribute meaningfully to innovation. But that thinking ignores the tremendous value that small businesses create by connecting us to our communities and, in part, creating them.

Economic models can’t capture the feel of neighborhoods. I know that I’ll be significantly less happy if the storefronts around my apartment — like the dumpling place where I used to get lunch, or Brooklyn Inn, where I met my fiancé — remain boarded up for the next few years.

If the small businesses behind those storefronts get replaced by soulless corporate chains, the cities we live in and love will be less lively too.

Katherine Waldock is an economist at Georgetown University and a fellow at the Millstein Center at Columbia Law.

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