Legal Briefs

Changing the Code

Recent changes to bankruptcy laws give landlords more leverage in tenant bankruptcies.

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse, Prevention, and Consumer Protection Act of 2005. While the act primarily reforms the bankruptcy laws affecting consumer cases, it also contains a number of amendments applicable to business insolvencies. One of the most significant changes involves the U.S. Bankruptcy Code and the treatment of commercial leases. Specifically, under the recent amendments debtor/tenants cannot extend the time to assume or reject commercial leases past 210 days, or seven months, from the bankruptcy filing without their landlord's consent.

The amendments affecting commercial leases apply to bankruptcy cases filed on or after Oct. 17, 2005. Commercial real estate owners, managers, and professionals should understand how this act changes landlords' and tenants' rights and obligations in bankruptcy, particularly with respect to the assumption or rejection of leases.

New Time Periods

Prior to the act, the Bankruptcy Code provided that debtor/tenants' unexpired commercial leases automatically were deemed rejected, unless the debtor assumed or rejected the lease within 60 days of filing for bankruptcy. However, the bankruptcy court was permitted to extend the time period beyond the initial 60-day period.

Before the act, the length of the extension was not limited, effectively leaving the decision up to the court's discretion. As a result, it was commonplace, especially in reorganizations of national retail tenants with hundreds of store locations such as Kmart, for courts to grant debtors' successive requests to extend the time periods to assume or reject their commercial leases. Extensions frequently ran up to 18 months, and some continued until the date a debtor's plan of reorganization was confirmed, often years after the initial bankruptcy filing.

These long extensions afforded debtors more time to formulate reorganization plans and to decide which stores and leases to keep, sell, or close. However, during this period debtors were permitted to operate their stores so long as they continued to pay post-petition rent. But debtors could not pay outstanding pre-petition rent until the bankruptcy court approved the debtor's request to assume its leases. Consequently, before the act, landlords often were forced to wait lengthy periods of time before learning what would happen to their leases.

New Amendments

The act amends the Bankruptcy Code in three significant ways. First, it increases a debtor's initial time period to decide whether to assume or reject a commercial lease from 60 days to 120 days after the bankruptcy filing.

Second, Congress placed an outside limit on extending the 120-day time period. The court may extend the 120-day period for up to 90 days only on the motion of the debtor or the landlord. A bankruptcy court only may issue such an extension prior to the expiration of the initial 120-day time period.

Third, and most important, the bankruptcy court must have the landlord's prior written consent to grant an extension after the 120-day period. Thus, a debtor/tenant's ability to extend the time period it has to assume or reject commercial leases cannot exceed 210 days, or seven months, from the bankruptcy filing without the landlord's consent.

Future Implications

The need for landlord approval past the 210-day limit on extensions should give landlords additional leverage in bargaining with their tenants in bankruptcy. Landlords can condition their consent to further extensions upon the debtor providing more rent or some other lease concession, which probably would require bankruptcy court approval. For example, landlords may require debtors to waive the right to reject their leases and "go dark" during the end-of-year holiday period in exchange for approval of an extension request.

Overall, these amendments should foster more substantive negotiations among debtors, lessors, and potential purchasers at an earlier point during bankruptcy proceedings. The amendments appear to favor landlords more than debtors, as Congress has attempted to level the playing field for landlords, particularly in national retail-chain bankruptcies.

Steven E. Ostrow

Steven E. Ostrow, JD, is a partner with White and Williams, LLP, in Philadelphia. Contact him at (215) 864-6248 or ostrows@whiteandwilliams.com.

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