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Top Ten Tips for Commercial Landlords When a Tenant Declares Bankruptcy

By Jill D. Laney and Christine Coers-Mitchell
Attorneys at Law, Cosgrave Vergeer Kester LLP

 

  • 1. Immediately stop efforts to collect back rent and to obtain possession of the property. Filing for bankruptcy imposes an automatic stay that prevents any action to collect past debts or to obtain possession of property in which the debtor holds an interest. Thus, phone calls and letters demanding payment for back rent are prohibited, as well as starting or continuing eviction proceedings and self-help lock outs. Actions taken against the debtor after the filing of bankruptcy are generally void in this jurisdiction. Furthermore, actions taken in violation of the automatic stay may subject the landlord to penalties, damages for any emotional distress caused to the debtor, and attorney fees.
  • 2. Communicate with your team. Make sure that everyone on the landlord’s team who is actively involved with the property knows about the bankruptcy filing as soon as possible. As explained above, property managers, collection agents and attorneys should halt actions that would violate the automatic stay. Furthermore, bankruptcy documents – and you may receive a lot – should be directed to the appropriate team member for immediateconsideration and action. Many events in the bankruptcy case affect the property, the landlord’s rights, and even other tenants’ rights. For example, the debtor may propose rejection of the lease, or assignment of the lease to a new tenant, or renewal of the lease at a lower rate. Deadlines for taking any action in response to such proposals may be very short. Making sure the correct person on the team has notice of these developments is key. Because of the complexity and timing involved, many landlords retain counsel to monitor the legal developments and insure that the landlord’s interests are protected.
  • 3. Make sure the tenant is current on obligations after bankruptcy is filed. Although a landlord is prohibited from taking an action to collect on debts incurred prior to the bankruptcy filing (pre-petition debts), a landlord may and should take action to insure payment of all obligations that become due after the bankruptcy filing date (post-petition debts). Generally, a tenant who uses leased property is required to pay rent and all other charges incurred post-petition, including pro-rated taxes and insurance, because use of the property benefits the tenant and his reorganization. If the tenant fails to make payments, the landlord can request that the bankruptcy court order the tenant to pay or allow the landlord to pursue eviction under the lease and state law. Even if the bankruptcy court gives the tenant extra time to pay post-petition obligations, bringing the matter up early can strengthen the landlord’s position later if the problem continues.
  • 4. Watch out for lease rejection problems. In bankruptcy, a tenant has the option to assume the obligations under the lease (assumption) or reject them and vacate the premises (rejection). Generally, the law requires a non-residential tenant to make this decision within 60 days of filing the bankruptcy or the lease will be deemed rejected. However, bankruptcy courts often extend the time to make a decision upon the tenant’s request. Several practical issues can arise If the tenant rejects the lease, including: (1) when must the tenant vacate the property and surrender possession; (2) what does the landlord do about personal property left by the tenant, which may be subject to the interest of another lienholder; and (3) who removes signs or trade fixtures? Because these issues may involve significant costs to the landlord and generally cause delay in releasing the property, they are often best dealt with by negotiating an agreement with the tenant before the lease is rejected or bringing the issue before the bankruptcy court at the time of the hearing on the tenant’s request to reject the lease.
  • 5. Watch out for a lease assignment. A common way for a bankruptcy tenant to scale down and generate funds is to assume and then assign an unprofitable lease to another party. This is particularly true when a national chain tenant goes into bankruptcy. If a tenant proposes a lease assumption and assignment, check to see if the assignment affects use provisions, tenant mixes and exclusivity rights of other tenants. Also ask for financial information regarding the prospective tenant. If the proposed tenant is unacceptable or you want to retain control over the lease, you should seek advice of counsel immediately. An anti-assignment clause in the lease may not protect your interests.
  • 6. Pay attention to renewal options during bankruptcy. Tenants in bankruptcy sometimes forget to timely renew a lease. Once the tenancy expires, the landlord has grounds to ask the bankruptcy court to order the tenant to vacate the premises and surrender the property to the landlord. Do not, however, rely on a default clause in the lease to prevent renewal. Bankruptcy courts generally refuse to enforce a lease provision that defines bankruptcy as an instance of default under the lease or as a basis to deny renewal.
  • 7. Adjust rent calculations. One of the greatest frustrations in dealing with a bankrupt tenant is getting the accounting straight. Often tenants filing for bankruptcy are already behind on their payments. Most landlords apply current payments to back-owing rent, taxes, insurance, cam and late fees. After bankruptcy has been filed, however, the landlord may only apply post-petition payments by the tenant to post-petition expenses. The debt incurred prior to bankruptcy must be left intact, to be paid, if at all, through the bankruptcy plan. Often the easiest way to handle this accounting problem is to create separate tenant accounts for pre-petition and post-petition debt as of the date the bankruptcy petition was filed.
  • 8. Don’t take that deposit without asking. Your tenant may have been required to give a deposit that is potentially refundable in whole or in part. Once a bankruptcy is filed, the deposited funds become an asset of the bankruptcy, and the landlord must obtain court approval to apply those funds to the tenant’s debt. Failure to do so is a violation of the automatic stay.
  • 9. File your claim. Although you may believe the chance of receiving any money from the bankruptcy proceedings is small, take the time to file a claim. Landlords usually get paid something on their claims, even if it takes a long time. And, in large bankruptcies, you may even receive an offer to purchase your claim from a third party.

You may prepare the proof of claim yourself or have your attorney do so. You will receive a blank “proof of claim form” that you must complete and return to the court or the designated claims agent by the “claims bar date” provided in the notice of bankruptcy received initially in the case.  You should attach to the proof of claim form a summary of the amounts the tenant owes separated into pre-petition and post-petition amounts as well as by category, for example, rent, cam, taxes, insurance, etc.  If the lease has been rejected, you should also show a separate calculation for breach of lease damages. 

  • 10. Practice prevention. Needless to say, bankruptcy can cut into the profitability of a property by creating added expense and loss of control over the lease. The best way to avoid the consequences of bankruptcy is to avoid being caught up in it. A lease that has been terminated under state law before bankruptcy is filed is not subject to the bankruptcy process. Thus, timely enforcement of a lease with a problem tenant can be a landlord’s best defense in avoiding the consequences of a tenant’s future bankruptcy.