Your Tenant Has Filed for Bankruptcy: What Should You Do?
Unfortunately, commercial tenant bankruptcies have become common and are likely to continue as a commercial landlord, what are your rights and what should you do when your tenant has just filed for bankruptcy protection? A landlord’s rights and obligations in bankruptcy are complicated and require case-specific review and analysis; however, this article addresses some of the major issues a commercial landlord needs to consider when faced with a commercial tenant’s bankruptcy.
The Automatic Stay
When a tenant files for bankruptcy, an automatic stay immediately goes into effect. The automatic stay is a statutory injunction that prohibits any actions by creditors, landlords, and others to obtain possession or control of the tenant’s property or to assert claims against the tenant, unless authorized by the Court or pursuant to a statutory exception. Therefore, if your tenant files for bankruptcy, you must immediately stop all efforts to collect past due rent or to dispossess the tenant – the failure to do so will likely result in your actions being voided and you could be sanctioned by the Court.
Post-Petition Rent
In exchange for the privilege of staying in possession of the leased premises after filing for bankruptcy, the tenant is required to pay you post-petition rent and to keep those rent payments current for as long as the tenant remains in possession of the premises. Unpaid pre-petition rent, however, is classified as an unsecured claim, which could be paid (to the extent funds are still available) with other unsecured claims after secured and priority claims are paid. Significantly, unpaid post-petition rent is entitled to be paid as an administrative claim, which is paid before unsecured claims. If the tenant fails to pay post-petition rent (or perform other lease obligations), you can file a motion with the bankruptcy court seeking either relief from the automatic stay in order to evict the tenant or an order compelling the tenant to pay such rent or reject the lease.
Assumption/Rejection/Assignment
After filing for bankruptcy, the tenant has 3 options: (1) assume (keep) the lease; (2) reject (breach) the lease; or (3) assign the lease. Commercial tenants have 120 days to make such a decision, which can be extended with cause for an additional 90 days. At the end of this 120-day (or 210-day) period, the lease is deemed automatically rejected if it has not been assumed.
A tenant assumes a lease if the tenant wants to remain in possession of the leased premises. In order to assume the lease, the tenant must cure all defaults under the lease, including paying all pre-petition and post-petition rent owing under the lease, and provide adequate assurance to the bankruptcy court that it will be able to perform future obligations required under the lease.
If a lease is priced over market or if the tenant determines that it does not want to remain in the leased premises, the tenant will reject the lease. When the tenant rejects the lease, the tenant must surrender possession of the premises and is no longer required to pay rent. The unpaid rent then becomes an unsecured debt of the bankruptcy estate.
If the lease is priced under market, yet not critical to the tenant’s ongoing business, the tenant may choose to assign the lease to a new party (even if the lease contains an anti-assignment provision). In such a case, the tenant must seek permission from the bankruptcy court and must satisfy all lease obligations, including the payment of past due obligations. Often, the new tenant (assignee) may be willing to pay the original tenant for the opportunity to take over the lease, and the original tenant is entitled to whatever sums it can negotiate with the assignee.
Proactive Steps
Bankruptcy can be a disruptive force in the marketplace, especially to commercial landlords. As a result, a landlord should be proactive in managing your tenants. Once a tenant becomes delinquent with its rent obligations, the landlord should default the tenant. If the problem persists, the landlord should seek to terminate the lease and/or dispossess the tenant. If the landlord is able to terminate the lease before the tenant files for bankruptcy, the tenant no longer has rights under the lease, and the landlord can evict the tenant without being subject to the arduous bankruptcy laws. Therefore, if you suspect that a bankruptcy filing by a tenant may be imminent, acting promptly when rent is not paid timely may be the difference between obtaining immediate possession of your premises or being dragged into bankruptcy court.
Conclusion
There are many complications that might arise when a commercial tenant files bankruptcy. The most efficient way for landlords to protect themselves is to get involved early in the bankruptcy process. By doing so, commercial landlords can help ensure that they will have the best opportunity to receive their rent and other payments due under the lease, as well as to make sure that any leased property that a tenant does not wish to retain can be vacated quickly.
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- Richard A. Mitchell
Partner