Legal Briefs

Bankruptcy for Landlords

Do you know what to do when your tenant files?

By Michael Zaverton |

You’re the owner of a commercial real estate property. One of your tenants is experiencing financial difficulty, falls behind in paying its rent, and then files for bankruptcy. The following questions and answers cover what you can and should do to protect your interests.

A Tenant Files

A bankruptcy case begins by the filing of a petition for relief in the bankruptcy court. This action creates a bankruptcy estate consisting of all the tenant’s — now a debtor — legal and equitable interests in property.

Lease clauses providing for lease termination if the tenant files for bankruptcy are unenforceable in bankruptcy. Thus, a tenant/debtor’s interest under an unexpired commercial lease is property of the debtor’s bankruptcy estate.

An automatic stay occurs the moment the petition for relief is filed, halting all creditor efforts to collect any claims that arose before the beginning of the debtor’s bankruptcy case. The automatic stay is strictly enforced. Creditors who violate the stay can be found liable for damages, the debtors’ attorneys’ fees, and, in some cases, for punitive or treble damages.

Thus, as a creditor, the landlord must immediately cease all collection or eviction efforts upon learning of the tenant’s bankruptcy. Once the lease becomes property of the tenant’s bankruptcy estate, any actions to enforce the landlord’s rights under the lease must be filed in the bankruptcy court.

How will you be notified of your tenant’s bankruptcy? Because you have an interest in the property that is subject to the lease, bankruptcy law requires that you be given notice of the bankruptcy and of any actions in the bankruptcy case that could affect your interest. Official notice of the bankruptcy will be made via a “Notice of Commencement” issued by the bankruptcy court. You may, however, receive notice of the bankruptcy by other means, such as a news report; an e-mail, phone call, or letter from the debtor or its attorney; or receipt of pleadings filed in the bankruptcy case.

How long does the trustee have to decide what to do with the lease? The Bankruptcy Code grants the trustee (or the debtor in possession in cases under Chapter 11 of the Bankruptcy Code) 120 days to review the lease and determine if it is valuable or burdensome to the estate. This deadline can be extended for an additional 90 days if the trustee demonstrates cause for an extension and the extension is granted before the initial 120-day period expires. No further deadline extensions can be granted without landlord consent.

Additionally, the Bankruptcy Code requires the timely performance of all debtor obligations under any unexpired lease until the lease is assumed or rejected. The bankruptcy court may extend the performance time of any obligations that arise within 60 days if the trustee establishes cause, but the time period cannot be extended beyond this 60-day period. Thus, the landlord should generally anticipate receiving timely payment of rent that comes due after the commencement of the debtor’s bankruptcy case.

What are the trustee’s options when it comes to the lease? In the event that a trustee determines that a lease is a valuable asset of the estate, the trustee can seek a court order authorizing the assumption of the lease by the debtor. Before the lease can be assumed, the trustee must cure or assure that it will promptly cure any defaults under the lease; compensate the landlord for any lost income suffered as a result of any default under the lease; and provide “adequate assurance of future performance” under the lease. Generally, evidence demonstrating a reasonable likelihood that the debtor will be able to fulfill its financial obligations under the lease will be sufficient to establish “adequate assurance of future performance.” A guarantee of future performance is not required.

The trustee can also assume the lease and assign it to a third party. The assignee must demonstrate that it has the ability to provide adequate assurance of future performance under the lease.

Although many leases contain anti-assignment provisions, these are generally unenforceable in bankruptcy. The assignment of an assumed lease relieves the debtor’s bankruptcy estate from any liability for any breach of the lease that occurs after the assignment.

Finally, the trustee may find that the lease is burdensome to the estate — the rent is too high or the space is no longer needed for the debtor’s business operations — and decide to reject the lease. Rejection of the lease can be accomplished by court order, following notice and a hearing, on the trustee’s motion for authority to reject the lease. Rejection of the lease can also occur by operation of law if the trustee fails to assume or reject the lease 120 days after the order for relief in the debtor’s bankruptcy case or by any extension of that deadline authorized by court order. The trustee is required to immediately surrender possession of the leased premises upon rejection of the lease.

Rejection of the lease, either by court order or by operation of law, is deemed to be a breach of the lease immediately before the date of the bankruptcy filing. In other words, your claim against the debtor for damages resulting from its breach of the lease will be treated as a prepetition claim against the debtor’s bankruptcy estate.

Michael Zaverton is an associate with Walter & Haverfield in Cleveland experienced in bankruptcy, creditor’s rights, and commercial litigation matters. Contact him at mzaverton@walterhav.com.