Have You Thought About ... What Happens When Your Commercial Tenant Files for Bankruptcy?

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Brownstein Hyatt Farber Schreck

The realities of a COVID-19-impacted economy have seen more and more businesses closing their doors. For landlords with commercial tenants, that means the possibility of facing multiple tenants going through bankruptcy proceedings as the ongoing and unpredictable effects of the pandemic come to bear.

Introduction

When a commercial tenant files a petition in bankruptcy to liquidate its assets (under Chapter 7 of the Bankruptcy Code), or to restructure (under Chapter 11 of the Bankruptcy Code), a landlord’s recourse is limited by an automatic stay that prevents the landlord from commencing an action against the tenant, and even from delivering a notice of default. Landlords should take a proactive approach to ensuring their ability to endure tenant hardships throughout the COVID-19 pandemic.

What Happens To The Lease Agreement If My Commercial Tenant Files For Bankruptcy?

With the filing of a petition begins the tolling of a 60-day clock (for Chapter 7 petitioners), or a 120-day clock, subject to a 60-day extension (for Chapter 11 petitioners), by which the trustee or tenant, as applicable, must either assume or reject the lease.1 During such period, a tenant may elect to remain in the leased premises, provided that such tenant is able to pay all post-petition rent and become compliant with lease terms within 60 days after filing, and thereafter remains current on such obligations.2 While landlords historically have expected to collect post-petition rental amounts from tenants continuing to occupy the leased premises, several bankruptcy judges have exercised their equitable authority to grant post-petition rental deferrals to tenants during the COVID-19 pandemic.3

On the expiration of the decision deadline for either a Chapter 7 or Chapter 11 tenant-petitioner, an election to reject the lease renders the leasehold interest terminated as of the date of the order or, on occasion, retroactively as of the date of the bankruptcy petition, and requires the tenant to surrender the premises.4 Rejection is generally a breach of the lease, and entitles the landlord to pursue damages.5 However, a landlord’s recovery following the tenant’s rejection of the lease is limited, as the claim is unsecured and the damages are capped under the Bankruptcy Code.6

If the tenant-petitioner elects to assume the lease, the tenant is obligated to cure all arrearages at the time of the assumption.7 A Chapter 11 tenant may also elect to assume the lease to be assigned in whole to a third party, provided that all arrearages are cured at the time of the assumption and the assignee provides adequate assurance of future performance under the lease.8 A retail shopping center landlord is afforded some additional protection in the event that a tenant elects to assume and assign the lease during bankruptcy, as approval of a proposed assignment requires that the assignee will not be in violation of any exclusivity arrangements or other provision regarding composition of the shopping center and will have a similar financial condition to the original tenant at the time the original tenant entered the lease, and that any percentage of rent owed under the lease will not substantially decline.9

What Should I Do to Protect My Property?

Six months into the unprecedented COVID-19 pandemic, few businesses are entirely unscathed by the impact of the disease and attempts to constrain it. Now more than ever, landlords shouldn’t wait until a tenant files for bankruptcy to develop a forward-looking strategy for their properties.

  • To the extent permitted-by-right under their leases, landlords should inspect the financials of all tenants to better understand their property’s financial strength. Landlords should deliver notices of default to any tenant whose current financials would constitute a default under the tenant’s lease or who is otherwise in default under such lease, before that tenant files for bankruptcy.
  • Once a tenant files for bankruptcy, most of a landlord’s recourse is halted. However, the automatic stay does not extend to prevent a landlord from pursuing draws against security in the form of a letter of credit or actions against third-party guarantors. Landlords may still look to a letter of credit or corporate guarantor for recourse during bankruptcy proceedings.
  • Landlords may continue negotiation of prospective concession amendments during bankruptcy. Without violating the automatic stay, a landlord and tenant may enter an amendment to the original lease during the tenant’s bankruptcy proceedings, provided that the amendment is beneficial to the debtor tenant’s estate.
  • During a tenant’s bankruptcy, landlords should be sure to receive and review notices of important deadlines to preserve their rights throughout the proceedings.

1 11 U.S.C. § 365(d).

2 11 U.S.C. § 365(d)(3).

3 See: In re Modell’s Sporting Goods, Inc., et. al., Case No. 20-14179 (Bankr. D. N.J.); In re Pier 1 Imports, Inc., et. al., Case No. 20-30805 (Bankr. E.D. VA); In re 24 Hour Fitness Worldwide, Inc., Case No. 20-11558 (Bankr. D. Del.).

4 11 U.S.C. § 365(p).

5 11 U.S.C. § 365(g).

6 11 U.S.C. § 365(h).

7 11 U.S.C. § 365(b)(1).

8 11 U.S.C. § 365(f).

9 11 U.S.C. § 365(b)(3).

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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