Strategies for the Commercial Landlord When A Tenant Files a Bankruptcy Case.

by David M. Reeder

When your commercial tenant files a bankruptcy case, the filing has a sudden, dramatic effect on your rights under the lease. The well-known landlord's remedies of a demand for payment of past due rent and a three-day notice, followed by the filing of an unlawful detainer action, can no longer be used once the tenant's bankruptcy filing has taken place. Instead, numerous provisions of federal bankruptcy law affect the enforcement of the landlord's remedies. Below are some principles and strategies for the landlord when the commercial tenant files bankruptcy.

Analyzing the Case; Judgment is Everything.

Not all tenant bankruptcies are bad. A successful outcome depends on the relative strength of the tenant, and numerous other factors. A successful chapter 11 reorganization case may result in "Tenant A" having a greater ability to make future rent payments, through a plan of reorganization. "Tenant B", however, may simply be too weak to survive, and an aggressive position is appropriate. Knowing how to assess the tenant's bankruptcy case, and determining what strategy to pursue, requires experience and a thorough knowledge of bankruptcy law and procedure.

The Effect of the Automatic Stay.

When a commercial tenant files a bankruptcy case, all actions to collect rent or evict the tenant are prohibited by the automatic stay. The automatic stay comes into existence, as a matter of law, upon the filing of a bankruptcy case. No bankruptcy court action or court order is required for the automatic stay to have effect. The automatic stay virtually prohibits any action that could benefit the landlord. Prohibited actions include serving or posting a three-day notice to pay or quit, filing or serving a complaint for initiating an unlawful detainer action, or communicating with the debtor in any way regarding the collection of rent, CAMS, or any other charges.

The Requirement for Payment of Post-petition Rent.

To balance the playing field between landlords and tenants, Congress enacted a provision of the Bankruptcy Code requiring chapter 11 debtors in possession to make all post-bankruptcy lease payments. This includes all amounts due under the lease including basic rent, percentage rent, CAMS, property taxes, and insurance payments.

Assumption or Rejection of the Lease.

The Bankruptcy Code gives the debtor the opportunity to assume or reject the lease. Rejection of the lease basically means termination of the lease and eventual surrender of the premises. Assumption, however, means that, under certain circumstances, the bankruptcy court can allow the tenant to assume and even assign the lease to a third party, without the consent of the landlord. This applies regardless of how well a non-assignment clause in the lease was drafted. The debtor is required to show "adequate assurances of future performance". Disputes over assumption and assignment of the lease in a bankruptcy case can have far-reaching effects for the landlord.

Deemed Rejection of The Lease.

In a chapter 11 case, if the bankrupt tenant (known as a debtor in possession) fails to take action in the Bankruptcy Court to seek to either assume or reject the lease, or to extend the time to assume or reject, within 60 days of the filing date, then the lease is deemed to be rejected. That means that the tenant's rights under the lease are terminated, without any further action by the landlord.

Extension of the Time to Assume or Reject.

Often a tenant in chapter 11 seeks an extension of time from the bankruptcy Court of the 60-day period to assume or reject the lease. The tenant is required to be current regarding post-bankruptcy rent in order to qualify for any extension of time.

Claims for Past Due Rent.

Federal bankruptcy law limits a landlord's claim for breach of a lease to the greater of 18 months rent, or 15% of the rent for the remaining term, subject to additional limitations. Rent which accrues subsequent to the filing of the bankruptcy case is a first priority claim, ahead of the claims of unsecured creditors.

If one of your commercial tenants has filed a bankruptcy case, or is threatening bankruptcy, contact David M. Reeder for a confidential review of your options.