Your tenant just filed for bankruptcy. Now what?

Monday 20 July 2020 - Filed under banrkuptcy + Contracts + debt restructuring + Landlord-Tenant law + Leases

Tenants who file for bankruptcy pose special challenges to landlords. This is especially so if the tenant has not been paying rent for some time before filing its bankruptcy petition.

The Automatic Stay:

The “automatic stay” comes into effect the moment a tenant files a bankruptcy petition.

The “automatic stay” means all debt collection activity must stop. Debt collection generally includes any landlord efforts to evict a tenant. If a tenant has filed for bankruptcy just before a landlord-tenant trial, the landlord-tenant court will most likely dismiss the landlord’s case. Exceptions may include non-residential leases that have already terminated or where the landlord has already obtained a judgment of possession. Exceptions turn on facts specific to the tenancy and local law and are often complicated. Even where an exception applies, the state landlord-tenant court judge may be reluctant to continue with the eviction case.

In general, unless there is some reliable exception to the automatic stay, the landlord must avoid any kind of interaction with the tenant concerning payment of rent or repossession of the property.

The landlord must seek relief from the bankruptcy court:

Once a tenant has filed for bankruptcy protection, the landlord must seek any modification of the automatic stay from the bankruptcy court.

The landlord should ask the bankruptcy court for an order modifying the stay to begin or resume eviction proceedings in the state court, federal court, or even in the bankruptcy court itself. Most often, the landlord will want to resume eviction proceedings in the state court because that is where expedited (“summary”) eviction procedures are readily available and more commonly handled.

Eviction often isn’t possible or even desirable during the COVID-19 pandemic given suspension of court proceedings in some locations and the swingeing destruction of so many tenant businesses and jobs throughout the country. There will be few replacement tenants for however long it takes for job creation to recover. There will have to be a lot of cooperation and understanding on all sides just to get through this crisis.

The Automatic Stay also affects the security deposit:

The security deposit is deemed property of the bankruptcy estate. Depending on the facts, the bankruptcy trustee may require turnover of the security deposit.

The landlord must not, on its own, apply (i.e., “setoff”), use, or do anything else with the security deposit without trustee waiver at time of claim allowance or else an order of the bankruptcy court modifying the stay giving the landlord permission to setoff.

To file or not to file a proof of claim:

The tenant ought to and typically will list the landlord as a creditor on its bankruptcy petition. The tenant will typically indicate the amount of rent owed to the landlord as well as the amount of the security deposit.

Among a number of choices, the landlord must decide whether or not to file its own proof of claim with the bankruptcy court. Depending on the facts, filing a proof of claim may or may not be advantageous.

Pre- and post-petition rent:

Set-off of the security deposit against rent owed, if any, will typically apply only to pre-petition rent, i.e., rent owed before the tenant filed its bankruptcy petition. Rent accruing post-petition becomes an “administrative claim.” What rent is pre-petition and what rent is post-petition may be complicated. There are different views on this. Bankruptcy court decisions vary by district. With regard to any bankruptcy issue, always consult current local case law and rules.

Administration and assumption or rejection of the Lease:

The tenant may not have sufficient income to pay for “administrative” (continuing) expenses – including accruing rent – that arise while the bankruptcy case is pending.

Even if the tenant has enough income to pay rent, it may continue to avoid paying rent for extended periods of time but also without vacating the property. Where a commercial tenant has many leases in different locations, as is the case with chain stores, this delay can ultimately make sense for the landlord, if the tenant manages to survive reorganization and resume paying rent. In other situations, the tenant may be abusing the bankruptcy code. Whether the tenant is behaving or misbehaving, the landlord is only permitted relief by order of or procedures occurring in the bankruptcy court.

The bankruptcy code includes various rules about “assumption” or “rejection” of the Lease or other kinds of so-called “executory contracts.” Assumption or rejection of executory contracts involves timing and other concerns which are beyond the scope of this article.

Residential vs. non-residential tenancies:

The bankruptcy code and case law are far more explicit about non-residential (commercial) tenancies than about residential ones. Where the code does not specifically address what to do in a residential tenancy situation, the bankruptcy courts have equitable power to render decisions appropriate to the facts and congruent with local state landlord-tenant laws.

Landlords must take prompt action in the bankruptcy court:

If a landlord has a challenging tenant who is neither paying rent nor vacating the property after filing a bankruptcy petition, as unfair as that may be – especially where local authorities expect the landlord to continue paying property tax, which, in some places, amounts to 40% of the rent burden passed on to the tenants – the landlord cannot expect any automatic help from the Court or even from the bankruptcy trustee. The landlord must promptly ask the bankruptcy court for relief from whatever the tenant is doing.

Remember that the bankruptcy court is designed to give debtors, whoever they may be, relief when business or life becomes unmanageable. Landlords can also seek bankruptcy protection. Where a landlord seeks bankruptcy protection, tenants may have their own justifiable concerns about the landlord’s performance of the rental contract.

2020-07-20  »  admin