For Landlords: The Importance of Seeking Legal Advice When Your Tenant Files for Bankruptcy

Author: McMillan Metro Editor Date: 09/24/2010

Categories: Commercial Leasing, Real Estate Law

A landlord must be prepared to protect its rights as soon as it receives notice that its tenant is in bankruptcy. The Bankruptcy Code provides tenants in bankruptcy with the right to either reject or assume leases. This is a powerful right that can have a significant affect on a landlord that is not keeping a watchful eye on the proceedings.

On the date a tenant files its bankruptcy petition, a clock begins to run on any leases that are in place. This means that the tenant must decide within a specific period of time whether it will reject (stop performing) the lease or assume (continue performing) the lease.

If the lease is of residential property in a chapter 7 liquidation case, the tenant must assume or reject within sixty (60) days after it files the petition. If the lease is of residential property in a chapter 11 reorganization case, the tenant must assume or reject before the date the court confirms the tenant’s reorganization plan.

If the lease is of commercial property in any type of bankruptcy case, the tenant must assume or reject by the earlier of (1) one hundred twenty days (120) after filing its petition or (2) the date the court confirms the tenant’s reorganization plan. This two-part deadline applicable to commercial leases is critically important to landlords since many months can pass before a reorganization plan is confirmed in a chapter 11 case. A reorganization plan must be accepted by the creditors in a chapter 11 case, and obtaining their acceptance can often be a long and difficult process. Current law therefore benefits landlords by stating that the latest date rejection or assumption can take place is 120 days after the tenant files its petition. If the tenant in any case fails or forgets to assume or reject a lease by the deadline applicable, the lease will be deemed rejected by operation of law and the landlord will re-take possession.

Naturally, tenants can and do obtain extensions of these deadlines under certain circumstances. Luckily for landlords, Congress added provisions to the Bankruptcy Code in 2005 that place limits on the extensions available in the various types of cases. In a chapter 7 case, a tenant with a residential lease may request an extension of the 60-day limit, but it will only be granted for good cause. A tenant may have good cause for an extension when there are multiple leases involved in the case or when the lease at issue is critical to the tenant’s reorganization. It is important for a landlord whose tenant requests this type of extension to ensure that the tenant affirmatively establishes the presence of “good cause”. In a chapter 11 case, a landlord with a residential lease can request that the court set a specific time within which the tenant must decide whether to assume or reject. Because this provision of the Bankruptcy Code requires landlords to take action in order to protect their rights, it is important that a landlord under a residential lease seek bankruptcy counsel soon after it receives notice that its tenant is involved in a chapter 11 case. A hard deadline will almost always benefit the landlord.

In any type of case involving a commercial lease, a tenant can request and receive one 90-day extension of the applicable 120-day deadline for good cause. Subsequent extensions will only be allowed if the landlord consents in writing. This written consent requirement is a powerful tool for landlords to prevent tenants from dragging their feet on the rejection/assumption decision.

So, what happens if a tenant timely rejects its lease? The Bankruptcy Code provides that a landlord under a rejected lease is entitled to damages of the greater of the rent due under the lease for one year, or fifteen percent of the rent due for the remainder of the lease, not to exceed three years. These damages may be reduced by the amount of any applicable security deposit, and increased by the amount of any rent due before the tenant filed its bankruptcy petition. Unfortunately for landlords, these rejection damages are treated as general unsecured claims, which means that they will be paid last, after other secured or higher priority claims are paid.

What happens if a tenant decides to assume its lease? Before a court will grant a motion to assume a lease, a tenant must show that it has cured all pre- and post-petition defaults and also establish that it will be able to perform its obligations in the future. This proof of future performance is referred to as “adequate assurance”. Adequate assurance may be in the form of additional security or payments, and it is critical that a landlord negotiate terms of an assumption it can live with. When a tenant decides to assume its lease, it may either assume the lease and perform its obligations itself, or assume the lease and assign its obligations to another party. Landlords should be aware that some anti-assignment provisions in leases are unenforceable in bankruptcy. They should, therefore, pay close attention to motions filed in their tenants’ bankruptcy cases to determine whether their leases are being assigned and be prepared to file formal objections, if necessary. Because deadlines for objecting to motions to assume and assign leases are short, commercial landlords should seek bankruptcy counsel promptly after they receive notice that their tenants are in bankruptcy.

For the reasons noted above, it is clear that bankruptcy can have a significant impact on residential and commercial real estate leases. It is essential that a landlord dealing with the bankruptcy filing of its tenant immediately seek legal advice on their rights under the lease to minimize their loss and maximize their legal options.