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What to Do When a Tenant Files Bankruptcy

Legal issues
What to Do When a Tenant Files Bankruptcy
by John A. Barclay

A tenant bankruptcy conjures up images of valuable space being interminably occupied by a deadbeat who neither pays rent nor allows the landlord to obtain a new tenant who will pay rent.

While bankruptcy is frustrating for all creditors, landlords who know the rules can protect themselves better than other creditors when dealing with tenants. When bankruptcy is filed, a landlord should know the status of the lease, what rights the tenant can exercise, and what options are available to the landlord. Through vigilance in the bankruptcy proceedings, landlords can maximize their recovery and even preserve their tenant despite past delinquencies.

Bankruptcy Basics

The legal position of landlords and tenants is best understood when basic principles of bankruptcy are known.

Bankruptcy chapters-Tenants in business file bankruptcy petitions under either Chapter 7 or Chapter 11. When a business files for a Chapter 7 bankruptcy, the court immediately appoints a trustee to liquidate all of the debtor's assets, to use whatever is available to repay creditors as much as possible. In a Chapter 11, the debtor keeps control of the business with a view toward continuing the operation in order to pay the creditors more money than they would receive in a liquidation. If the business cannot successfully reorganize, a Chapter 11 case may be converted to a Chapter 7 case; when this happens, the court appoints a trustee.

Types of claims-Obligations of a tenant created before bankruptcy is filed are referred to as "pre-petition" claims. Claims or debts created after filing are "post-petition" claims.

If the tenant stays in the premises any time after the bankruptcy is filed, the claim for rent for this period of time is considered an "administrative claim." Administrative claims are post-petition claims and are paid before any other claims in the bankruptcy, whether the tenant has filed a Chapter 11 or a Chapter 7. Thus, to the extent that there is any money to pay any creditors, the rent incurred after bankruptcy commenced will be paid. If there is not enough money to pay all administrative claimants (those people providing goods or services to the bankrupt tenant after commencement of the bankruptcy), then the administrative claimants all share proportionately in whatever money is available.

Rent owed for periods before bankruptcy was filed, known as pre-petition rent, is an "unsecured" claim. This is the last type of claim to be paid and, if paid at all, is almost certain to be severely discounted.

Automatic stay - When a tenant files for bankruptcy, all collection actions against the tenant stop. This includes unlawful detainers or other efforts to collect money. Filing bankruptcy creates an "automatic stay," which means that creditors cannot take any action against the debtor without court permission. However, the landlord can still pursue and collect back rent from any guarantors named under the lease, even while the tenant is in bankruptcy.

Conditions for Terminating a Lease

After bankruptcy -Virtually all leases contain provisions that say that if the tenant files bankruptcy, the lease is breached and the tenant can be evicted. Regardless of what the lease states, however, the law forbids the landlord from declaring a termination or breach of the lease as a result of bankruptcy. Furthermore, provisions that make performance of the lease more onerous after bankruptcy is filed rather than before are also unlawful. For example, a lease cannot require a tenant to pay more rent or increase a security deposit because of the bankruptcy.

Before bankruptcy - In most states, a lease is terminated when the landlord has given a notice to pay rent or to quit and the tenant does not pay rent by the end of the period of time required by state law or agreed to in the lease (usually three days). If the landlord accepts rent at the end of the notice period, the lease remains in effect, even though the landlord might have previously terminated. In fact, accepting a partial paymentrequires the landlord to give another notice to pay rent or to quit; in order to terminate the lease, the new notice must expire without any payment. Thus, a tenant making any payment that the landlord accepts after the notice period expires is able to claim that the lease is in effect when bankruptcy is filed.

If the landlord has terminated the lease before bankruptcy, then the tenant has no right to continue the lease after bankruptcy is filed. At the same time, the landlord cannot continue any pending unlawful detainers without permission of the bankruptcy court. However, if the lease is terminated and the tenant is not paying rent, the landlord will be able to quickly evict the tenant.

Status of Leases in Bankruptcy

If a tenant's lease has not terminated when a Chapter 7 or Chapter 11 bankruptcy is filed, then the tenant must assume or reject the lease within 60 days of filing bankruptcy. Before the 60 days are up, the tenant may make a motion to the court asking for an extension of the 60-day period. The landlord must be told what date the 60-day period expires.

It is important that the landlord be mindful of deadlines and motions made by the tenant concerning the lease. When the tenant asks the bankruptcy court for permission concerning any aspect of the lease, the landlord receives notice and must state its position. The landlord is dependent upon the rent and common area reimbursement expenses to pay the mortgage and to pay for other services such as maintenance, repairs, and insurance. The landlord must express to the court the impact of the tenant failing to promptly pay its obligations, particularly emphasizing the financial burden and the potential and real detriment to the landlord's entire project.

Effect of tenant assumption -A landlord should not assume that a debtor in Chapter 7 will automatically reject the lease. Even though a business is being liquidated, a trustee might still choose to assume the lease of a profitable (or potentially profitable) retail location so that the business of the debtor can be sold as a going concern at that location, or if the lease at that location is sufficiently valuable, the trustee may assume the lease in order to sell or sublease the property. A debtor in Chapter 11 may also attempt to sell some of its locations or leasehold interests in order to raise additional funds for the continuing business.

A tenant who assumes a lease in bankruptcy is agreeing to fulfill all the terms of the lease. If the tenant was in default of the lease at the time the bankruptcy was filed, then the tenant must make up the delinquent rent within a reasonable period of time. This is one of the few times any creditor in a bankruptcy can collect money that was owed before the bankruptcy was filed. If all the delinquencies are not cured by the end of the 60-day period, then the court must approve the tenant's efforts to establish that all arrearages of rent and other obligations under the lease can and will be paid within a reasonable time, normally no more than a few months.

Rejection of lease -The bankrupt tenant has the right to reject the lease within the same 60-day period. If the tenant does not assume the lease, it automatically rejects, or cancels, the lease. A tenant can reject a lease before the 60-day period expires. The landlord cannot do anything to stop a tenant from exercising the absolute right to cancel a lease. The landlord and the tenant, however, can negotiate a new lease that will be valid and binding if approved by the Bankruptcy Court.

When the debtor rejects the lease, the landlord can obtain an immediate order from the bankruptcy court to force the tenant to vacate the premises. This can be far more expedient than the conventional unlawful detainer. Additionally, in this situation the bankruptcy court is the tenant's last resort, whereas in the usual unlawful detainer, the tenant has a variety of tactics that can delay eviction (including filing bankruptcy).

The landlord's losses as a result of the tenant rejecting the lease are only an unsecured claim, even though the actual rejection does not occur until after the petition in bankruptcy is filed. In this instance, the value of the future rental stream that the landlord receives under the new lease is no better than pre-petition, unpaid rent. It will fall under the lowest class of claim and result in the landlord being paid only a certain percentage of back claim. Any lease that obtains from the premises after the rejection can be used to offset any losses from the rejection.

Working with Tenants to Minimize Losses

The landlord's ability to minimize losses from bankruptcy could depend on how the landlord conducts business with tenants who are in default but have not yet filed for bankruptcy.

Preference rules -When working out a new lease arrangement with a tenant who is in default but has not filed for bankruptcy, a landlord must be careful not to violate "preference" rules. The preference rules, which apply if the tenant subsequently files for bankruptcy, were established to stop one creditor from gathering the debtor's assets to pay pre-petition bills to the disadvantage of the other creditors. Although preference rules can be complex, they generally work this way: a payment to a creditor can be treated as a preferential transfer if the money was owed for more than 30 days before the date of payment and if the payment was made within 90 days before the debtor filed for bankruptcy. If it is a preferential payment, then the creditor can be forced to repay the money that was justly paid by the debtor before bankruptcy. In this way, the debtor (or all the other creditors) will have the payment available to pay claims or continue the debtor's business operation.

Thus, any time a landlord receives a payment for rental arrearages that are more than 30 days overdue and the debtor files bankruptcy within 90 days of that payment, the landlord runs the risk of the payment being treated as a preference. Since the landlord does not know whether the debtor will file bankruptcy within the next 90 days, the landlord must be cautious about how the lease and payment of back rent is negotiated.

Should the debtor assume the lease, then a payment made to the landlord within 90 days of the bankruptcy is not treated as a preference, since the landlord will be entitled to the payment as part of the assumption of any lease. If the lease is rejected, the debtor or trustee in bankruptcy may require that the money received within the 90-day period be returned. There are precautions a landlord can take to reduce the prospect of a debtor being able to claim a payment made 90 days or less before the bankruptcy is a preferential payment.

Non-bankrupt delinquency - Landlords need to evaluate not only whether a tenant is likely to avoid bankruptcy, but also what could happen in the bankruptcy. Several steps can assist in doing this. First, a landlord should always get a current financial statement on the debtor. If the tenant has adequate assets to pay all of its creditors on liquidation (even though the tenant normally is expected to pay all of its creditors when money is due) then the landlord is in a safer position to accept the payment without it being characterized as a preferential transfer. One requirement of a preferential transfer is that the creditor receive more than he would have received in a liquidation.

Second, the landlord should obtain affirmative representations from the tenant about the tenant's financial condition. If the representations support the adequacy of the tenant's net worth, they will act as presumptions in any proceedings brought by the tenant in bankruptcy against the landlord.

Third, consider forgiving the back rent altogether and entering into a new lease. Rental under the new lease can be increased as a means for paying the old rent. If the tenant is willing to give the landlord cash to pay the old rent, then the cash can be accepted as an increased security deposit for the new lease. The new lease can give the tenant the right to apply a certain amount of the security deposit to future rent without breachingthe new lease.

Finally, the landlord can get a guarantee of the payment of the rent, or can receive the actual back due rent payment directly from a pre-existing guarantor rather than from the tenant. If the guarantor receives the money from the tenant, the landlord can argue that any preference problem is a problem for the guarantor and not the landlord.

Re-Leasing the Premises

Once the tenant has either defaulted or filed bankruptcy, landlords should constantly be trying to re-lease the premises. Since many prospective tenants look for space well in advance of the need to relocate, a landlord can be planning for a new tenant. Knowing the bankrupt tenant must assume or reject the lease enables the landlord to plan for another tenant or continue the same tenant.

The prospect of losing a potential new tenant is also a good reason not to allow the bankrupt tenant additional time to assume or reject a lease. Tenants frequently make requests for such extensions because they do not know how they will reorganize their business when they file bankruptcy. For example, a retail chain that files bankruptcy may not know within 60 days which stores it will keep (assume the lease) or which ones it will close (reject the lease).

Vigilance is Key

The specter of bankruptcy can threaten the economic viability of a real estate property. And, unfortunately, the rules of bankruptcy are complicated and often confusing. However, by knowing the rules, by planning for bankruptcy when negotiating with delinquent tenants, and by being well aware of the debtor's maneuvers in bankruptcy, landlords can minimize the losses and maximize the predictability of regaining rent.

Comments

Deadbeat tenants Abigail Ellis and Warren Lee Ellis

Bonnie and Clyde here are taking turns filing Chapter 7. The dead beats have not paid rent for 6 months now and the court continues to cancel all eviction proceedings because of their chapter 7 filings. My stupid property managers found these two idiots after they had just been evicted by someone else a month prior to moving in to my house. Abgail Ellis aka Abigail K Stine (DOB: 12/12/1982). BE AWARE of this dead beat in the county of Montomgery in Pennsylvania.

advertising property prior to tenant being notified or breached

I am behind 2 months in which I have the rent and was merely 15 days behind when I attempted to pay. LL refused rent and I found that he has been advertising my shops location (commercial Property) for the last 6 weeks. Prior to being late. LL can get more rent per square foot now. I have 2 years left on lease. I am in California. What are my rights when it comes to advertising my space prior to me vacating, or being served pay or quit notice?

What to do after you receive a letter chapter 13 from a renter

I had a renter that file for chapter 13. The contract ended in 2011 and after numerous small payments now if filing for chapter 13. What I need to do I this case any hep will be appreciate.

Deadbeat Tenants

I really think the law protects the deadbeat renters more,we have tents that have not paid rent in months and now a day before the court hearing they filed bankruptcy. Plus we found out they make a living doing this and have been evicted many times before. It's not fair that they can get away with this. Where is justice for the good people that have to work hard for what they want?
Anyone with advice please reply.

CHAPTER 11

I have a tenant who has not paid rent in 6 months and is a dead beat who has breached the lease in several ways. Denying access to property, menacing animals (pit bulls) as well as illegal occupants that are not listed on the lease. She is passive aggressive and is doing everything she can to stay, while stating that she will leave. She has filed chapter 11 and thinks that she can squat and not pay while creating more issues with codes and false claims. She does not respond to notice or phone calls. So, YES!!! she is a deadbeat.

People always assume the worst

I have never paid my rent late. I don't owe my landlord anymoney and I'm moving out by choice because I am going to reject our lease. My wife and I had to file bankruptcy because of some problems we have had. We are current on our rent and since my landlord found out we were filing bankruptcy he has harassed me everyday. In fact he has harassed me every month. He had problems with his last tenant and had called us a week before the rent is due every month we lived here. Now we are filing and to be honest while we probably could afford to continue the lease we are getting out while we can. I'm sorry but just because people have financial problems doesn't mean they are deadbeats. I work my butt off everyday, but sometimes things are out of your control. I can assure you I would not be filing bankruptcy if I had any other choice

Both sides.

I've been a renter and a landlord. Sometimes as a renter it is hard to remember that the landlord owns the property you are living in, it is their investment, have expenses related to it, and they generally have a lot of money tied up in it. Often times the money made via renting their property is their income. Most landlords are not rich, looking to take advantage of someone down on hard times. They quite often cannot afford to let someone live in their place for free or at a reduced rent. Basically, our renters hard times should not have to turn out to be our own.

I'm fine with cutting some slack here and there, but I absolutely would not let a tenant live in my property for free or at a reduced rent unless they were a model tenant that I never had any other issues with in the past. You would not be allowed to walk into a Target and take something off the shelf for free or at a reduced price just because you have fallen on hard times, and you should not expect the same from your landlord with their property. If you are able to work out a suitable situation with your landlord, be thankful, but if he/she does not agree in modifying the terms of the lease, the renter has no right to be bitter about it.

I TOTALLY AGREE W/U

I TOTALLY AGREE W/U

renter filed bankruptcy

I have a house that has been rented since August 2012, I just recieved notice the tenants have filed Chapter 7, Are they still obligated to pay rent, and can I put the house up for sale at the end of the term of the lease?

Are Landlords Bullies?

I find it unfortunate that while the posts here are all about people in difficult times going through bankruptcy - the general theme is the landlord must be the bad guy and be forgiving.

I truly feel for both sides of the story above where the landlord has gone 1 1/2 years with no rent while the resident is trying to figure things out. It was now made to look like the landlord is being mean because they are pushing for some type of closure to this chapter. Unless the landlord is very wealthy, I have no idea how they allowed this situation to go on.

Ultimately people, the landlord has expenses that must be paid as well. At what point have you not heard about the banks that have been even MORE unforgiving and foreclosed on properties where the mortgage is not being paid. I read about bankruptcy is not about deadbeats. But one could argue the same about prescription substance abuse not being drug addicts. Nobody started out that way, but at the end of the day, the situation is what it is. The person filing bankruptcy is doing so at the expense of someone else not getting paid. The prescription substance abuser ends up being addicted to pain killers and now can't live without them. Call them what you wish, but the results - good or bad - are the same.

Remember, it's not just about you, but the obligations YOU have created that you must unfortunately not fulfill.

I had a buyer that wanted to

I had a buyer that wanted to buy a home in Arizona, but he had a Chapter 7 bankruptcy 7 months ago. After researching the web I found a loan program at http://www.cfsflex.com, they allow a mortgage after a foreclosure, short sale, or bankruptcy. There is only a six month waiting period. Good to see lending options coming back.

back rent

I do not have a written lease. It is rental from month to month. I am behind on rent. I was going to be evicted a couple of weeks ago. My landlords knew of my financial issues which are a result of major medical surgeries [heart] and I kept them apprised of my situation. The landlord said do what I can.

I have honestly tried to catch up but haven't been able to. I wrote a note to my landlord letting him know what my debts are besides rent. I am on unemployment, I listed what I get for unemployment payments, my debts, my medications, I listed when I get paid [the dates] and because they wanted 870.00 per month [570. monthly rent and 300. on back rent] I made the first payment on May 11th.

I did ask that they let me stay. My reason for staying is I need time to find another place. My question is since I wrote this letter to them I received a letter from their attorney saying I agreed to the 870 a month for back rent [lawyer didn't indicate anything about the 570 being included in this payment for current rent]. I didn't sign anything from the landlords or the attorney. I owe back rent for 1 1/2 years [which landlords at the time were working with me to figure things out]. I have been working with lawyer and chapter 7 bankruptcy will be filed in the next few weeks. The notices to the creditors have not gone out yet. Can the landlord contest my bankruptcy to write off the debt with them and win? Will the court insist that I make payments to them even if filing the bankruptcy. The letter was written last week and I received the letter from their attorney on the 11th. Because the bankruptcy hasn't been filed yet and the notices not sent out to creditors yet will my filing VOID the letter that I gave them? Please, I am desperate for an answer.

A tenant on Ch7 is Not A Deadbeat!

Stop making assumptions that people who file for bankruptcy are deadbeats. There are many reasons this happens, and is not by choice.

For example, I have tried to inform my landlord of my dire situation and tried to pay in increments.. He is now harrassing me daily. Now its become messy.
He is now breaking the law by harassing me.
What to do in a sticky situation. Im at a loss.

MK in Cali.

Harrassing???

You owe this person money, how do you know it is not affecting food for his family now? Own up to it and find amicable ground. I have a tenant that has not paid rent in 2 months, she had a place to stay for FREE for two months while I worked overnight to keep the property? I would call every other day until you paid. That is not harassment unless he is knocking on your door everyday or calling you ten times a day. You owe them money, so pay them!

How would you feel if you toilet didn't flush and it took the landlord two months to fix it? Wouldn't you harass them because you can't use the restroom??? The shoe fits both ways and I hate those that hide behind the laws of entitlement versus responsibility.

Tenants Rights AFTER Bankruptcy

Thank you so much, most of the time the landlords are bullies and most areas of the United States DO NOT have tenant - landlord laws to protect us...Thank God there is something to assist us through trying times...Not everyone is a deadbeat that has not made the rents...In my instance, my husband keeps deserting our household and spending the money on himself at his age of 54 yrs old...still doing the same crappy things from his youth. And its effects me and my livelihood! I am very sorry do have to do this, but this is one the ONLY ways to restructure my life after my husband's constant abuses to me. Have a blessed day for the information.

yes, he is a deadbeat and

yes, he is a deadbeat and your an idiot for letting him back in the house....how is both your stupidity the landlords problem? It simple, get rid of the husband, keep your money and pay your responsibilities.... why are people always playing the poor me card.

RE: Timing for assumption or rejection of lease

Under 11 USC 365(d)(4)(A), the tenant has 120 days to reject or assume the lease of nonresidential real property.

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John A. Barclay is the managing attorney with Barclay Law Corporation, Newport Beach, California. Barclay practices in the areas of real estate, bankruptcy, business, and environmental law. He frequently speaks on a range of legal topics. Barclay can be reached at (800) 847-5432 (in California only) or (714) 476-2672.

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