With Tenants Increasingly Filing for Bankruptcy, There are Steps a Commercial Landlord Can and Should Take

Under the current economic conditions, commercial landlords are finding with increasing regularity that tenants are routinely paying their rent late, requesting for a release of obligations in the lease, or keeping lower numbers of staff or inventory. Commercial landlords should take note if they have experienced these troubling signs, which along with “hearing it through the grapevine,” are all indications a tenant may be considering bankruptcy. But whether they have seen the signs or have already had a tenant file for bankruptcy, commercial landlords can take steps to protect themselves.

A Tenant is Threatening Bankruptcy

If a landlord thinks bankruptcy may be imminent, it should send all default letters required under the lease to notify the tenant of its defaults and reserve all of the landlord’s rights under the lease and the law.

The landlord also must determine what its goals are for that particular space and tenant. If the leased space is in high demand and easily re-rentable, the landlord might negotiate with the tenant for a voluntary lease termination and vacancy. If the landlord wants to maintain the current tenant, perhaps a renegotiation of the lease terms is in order to reduce the pressure on the tenant.

If the tenant is unwilling to cooperate, the landlord must examine its other potential remedies, including termination of the lease, or filing suit for eviction or rent due under the lease. Keep in mind that filing a lawsuit may push a tenant who is just considering bankruptcy into actual bankruptcy.

A Tenant Has Filed for Bankruptcy

Once a tenant has filed for bankruptcy, filing suit for either eviction or unpaid rent is impossible without the permission of the bankruptcy court. Even suits which already have been filed against the tenant are halted by the filing of the bankruptcy case. The “automatic stay” is one of the most basic protections that come with the bankruptcy filing. All collection actions must be halted and creditors can no longer pursue the debtor directly. All of the tenant’s rights and assets are considered part of the bankruptcy estate and under the exclusive control of the bankruptcy court. Most decisions involving the management of the tenant or payments to any other person have to be approved by the court.

Assuming that the tenant is in default and has not paid at least one month’s rent before it filed for bankruptcy, a document called a ‘proof of claim’ should be filed as soon as possible. A proof of claim is a form document, which informs the court that the debtor owes money to an entity, the amount of money owed, and the basis for the amount owed. It also allows the landlord and its attorney to receive notices from the bankruptcy court which might affect the lease.

What Happens to the Lease after Bankruptcy

A lease is considered an “executory contract” under the Bankruptcy Code, meaning that it is a contract where one or both parties still have obligations to perform. In the lease, the unperformed obligations are the tenant’s duty to pay rent and the landlord’s duty to provide possession of the leased premises. The Bankruptcy Code provides that executory contracts, like leases, have to be accepted or rejected by the debtor. Both of these options will significantly affect the landlord.

When a lease is rejected, it means that the lease is considered to be breached as of the date of the rejection. All amounts which remain past due for the time period before the rejection remain outstanding, but there is no further obligation to perform by either the landlord or the tenant. The tenant must surrender the premises immediately and has no further obligation to pay rent or any other charges due under the lease. The remaining unpaid amounts due to the landlord will be treated as any other general unsecured claim and paid either wholly or in part, depending on the plan approved by the Bankruptcy Court.

The landlord may also make a claim for damages due to the breach, but there is a cap on the amount of damages, which may be awarded. In bankruptcy court, damages for breach of lease are limited to the total of one year’s rent or 15% of the entire lease term if the term is no longer than three years.

A lease may also be accepted, meaning that the debtor has decided that it wants to keep the lease in full force and effect. No changes are made to the lease; all of its provisions remain effective and all payments due under them must be made timely on a going forward basis. However, before a lease can be accepted, the debtor must cure all previous monetary defaults. Payments under an accepted lease are considered administrative expenses of the debtor and are given priority over most of the other claims by other creditors of the tenant.

While the landlord does not have any input on this decision and it remains fully within the rights of the debtor whether to accept or reject the lease, the commercial landlord is not wholly without protection while the decision is made. From the time the bankruptcy filing is made until the lease is assumed or rejected, the tenant must make all payments due under a non-residential lease and those payments are entitled to priority over other payments to other creditors. The debtor has a set period of time when it must decide whether to accept or reject the lease.

• In Chapter 7 liquidations, the time period is 60 days.
• Under a reorganization-type bankruptcy, the time period is 120 days, although the bankruptcy court can grant an additional 90 days if there is good reason.
• If there is no decision within these time periods, the lease is deemed to be rejected and the landlord has the right to regain the premises.

An Assignment of the Lease by the Tenant

Another issue, which may arise, is the assignment of the lease by the tenant. The Bankruptcy Code provides that a tenant in bankruptcy may ignore a provision in the lease which states that it is non-assignable or assignable only with the landlord’s permission. The tenant in bankruptcy may assign the lease if the lease is accepted (meaning it is also cured of any past default) and there is an “adequate assurance of future performance” by the new tenant. Whether there is adequate assurance or not is usually determined by the bankruptcy court, although the landlord may be able to offer some input in this determination. In situations where the leased premises is in a shopping center, the court may take into consideration the tenant mix of the shopping center and any exclusivity provisions in the lease of the anchor tenant, among other factors. Ultimately, however, there can be an assignment of the lease over the objection of the landlord.

Monitoring the Bankruptcy Process is Critical

There are many tactics that the tenant debtor may take to delay or avoid certain payments to the landlord creditor. Since the bankruptcy court may provide for limited time to object to certain debtor proposals, it is essential that the landlord and its attorney closely monitor the bankruptcy process from filing though payment of the landlord’s claim. Although the bankruptcy law usually heavily favors the debtor, there are many protections built in for the creditors, including the landlord creditor, but they must be affirmatively enforced by the landlord itself.