Five Takeaways for Commercial Landlords When Tenants File Bankruptcy

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COVID-19 Pandemic Likely to Increase Bankruptcy Filings

As the COVID-19 pandemic forces authorities across the country to swiftly react to public health developments and setbacks, the process of reopening businesses to the public has experienced more than its fair share of uncertainty. Commercial landlords may encounter — or have already encountered — tenants filing for bankruptcy in the face of uncertain economic conditions. It is critical for landlords to understand that bankruptcy brings with it a special set of rules that will require the parties to approach the situation from a different perspective than the traditional landlord-tenant business relationship.

Here are five initial considerations for commercial landlords to keep in mind when presented with a tenant filing for bankruptcy:

1. Respect the Automatic Stay!
Upon initiation of a bankruptcy case, an automatic stay is imposed, prohibiting nearly all forms of creditor action against the bankrupt debtor. While the threat of filing for bankruptcy is sometimes used as a negotiating tactic, the initiation of a bankruptcy case brings to a halt all litigation and collection efforts against the debtor. Landlords and their attorneys can be sanctioned for violating the automatic stay by, among other things, commencing eviction actions, requesting pre-bankruptcy back rent from debtors and even calling and demanding payment. The bankruptcy court will not hesitate to enforce the stay, as it is one of the most important protections under bankruptcy law. Moreover, the automatic stay is self-executing and imposes an affirmative duty upon creditors to comply.

2. Move Quickly
There is no “opting out” of a bankruptcy for creditors. Upon receiving notice of a bankruptcy case, commercial landlords should immediately contact bankruptcy counsel to protect their rights. In large retail bankruptcy cases, for instance, a debtor might file motions concurrently with its bankruptcy petition to immediately reject (breach) a number of under-performing leases, or to abate or defer rent. Landlords may need to respond within the first few days of a bankruptcy case to protect their rights.

If a landlord initiated eviction proceedings before the bankruptcy case was filed, the landlord may want to quickly move for relief from the automatic stay to proceed with the eviction. Under California law, a landlord’s serving of a Notice to Quit, and the expiration of that notice period prior to the bankruptcy filing, takes that lease out of the bankruptcy case entirely.

3. Assumption and Rejection of Unexpired Leases
As part of the bankruptcy process, unexpired real property leases must be either assumed or rejected within 120 days of the bankruptcy case filing date (although this deadline can be extended upon motion by the debtor/trustee). If assumed, the lease resumes in full force and effect despite the bankruptcy filing and/or default of lease terms by the debtor, so long as all lease defaults are cured. Following assumption, a debtor may also move to assign the lease to a third party upon a showing of adequate assurance of future performance of the lease.

Alternatively, debtors may reject the lease, in which case the real property is surrendered and the lease is considered legally breached. Landlords are entitled to file a rejection damages claim, consisting of any pre-bankruptcy amounts owed and damages for breach of the lease agreement, capped at the greater of one year’s rent or 15 percent of the remaining lease term. Landlords may also be entitled to file a motion for an administrative claim for debtor’s post-petition use of the property. Administrative claims are of higher payment priority than rejection damages.

4. Ipso Facto Clauses: Popular But Unenforceable
Many commercial leases contain ipso facto clauses: provisions that grant a party the right to terminate or modify the agreement upon a debtor’s bankruptcy filing or insolvency. Commercial landlords beware: such clauses are generally unenforceable once a bankruptcy case has been filed. If the lease was unexpired at the time of the bankruptcy filing, the debtor or trustee still has the right to assume or reject the lease under section 365 of the Bankruptcy Code, despite the existence of an ipso facto clause in the lease.

5. Protect Your Claim
While the automatic stay precludes landlords from collecting pre-bankruptcy unpaid rent, debtors are required to pay post-bankruptcy rent and to comply with all lease provisions while they decide whether to assume or reject the lease. The failure to do so results in an administrative claim (see above).

Do not assume that a tenant’s filing of a bankruptcy case means that landlords should resign themselves to receiving pennies on the dollar for unpaid amounts under existing leases. While the main purpose of bankruptcy is to provide a “fresh start” to debtors, an equally important purpose is to provide a pro rata distribution among creditors of a debtor’s assets. Landlords whose leased locations are considered “performing” locations have a better chance of their leases being assumed and assigned to a third party, conditioned upon full cure of all lease defaults.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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